A midyear money-saving checkup: minor adjustments now can put a smile on your face next April 15

Kiplinger's Personal Finance Magazine, July, 1998 by Marc L. Schulhof

Minor adjustments now can put a smile on your face next April 15.

Take a moment to think about your last visit to the dentist, if you can remember it (and who could forget?). It probably prompted a few grimaces and maybe even a solemn oath to floss every day.

You didn't floss this morning, did you? The memory of that dental discomfort has faded. But a few months from now, when your next appointment looms, you're going to be flossing like crazy.

It's the same way with taxes. After you complete your forms in the spring, you want nothing more to do with tax paperwork--ever. By now you've slipped easily into a pleasant state of disregard, where you'll dwell until some earnest end-of-the-year tax article jolts you into a frenzy.

There is a better way: Give yourself a midyear tax checkup right now. You'll cut your taxes more by doing a bit of lazy-days-of-summer planning than by scrambling around at the last minute.

PAY AS YOU GO ... MAYBE. Converting a traditional individual retirement account to a Roth IRA could be among the best financial moves you make this decade. Many people worry, though, that making the switch--which means most, if not all, the money that's moved will be treated as taxable income--will force them to make quarterly estimated-tax payments this year. Most converters need not worry. Their tax bills won't be due until next spring.

The demand for estimated payments is triggered only if withholding from your paycheck falls at least $1,000 short of either 90% of what you'll owe in 1998 or 100% of what you owed in 1997. That 100%-of-last-year's-tax rule protects most IRA converters--including you, if you're among the more than 70% of taxpayers who got a refund last year. If your salary is about the same or has risen this year--and you didn't cut your withholding--then you'll easily with hold more than 100% of your 1997 bill. So there's no need to pay estimated tax on your conversion.

Even if that rule doesn't protect you, there are ways to avoid the hassle of estimated-tax payments. Consider the choices open to Mike and Chrystal Jones, who plan to convert $39,000 in IRAs to Roth accounts.

The 100%-of-last-year's-tax loophole doesn't work for them because Mike quit his job to start business school at Purdue University and there's no way withholding on Chrystal's income this year will match their 1997 tax bill on two incomes.

But just one-fourth of the $39,000 will be taxed in 1998 (the rest will be spread evenly over the next three years), adding about $1,500 to the Joneses' tax bill. And, remember, as long as withholding comes within $1,000 of what's actually owed, there's no need for estimated payments. By increasing her withholding a bit between now and the end of the year, Chrystal can cover the gap.

Alternatively, if the Joneses wait until September I to make the conversion, their first estimated payment won't be due until next January 15--and they can skip it even then if they file their tax return by February 1. (If the conversion is made between now and the end of August, 50% of any estimated tax is due September 15.)

If you need to boost your tax payments because of an IRA conversion, get a copy of IRS Form 1040-ES, "Estimated Tax for Individuals" (800829-3676, or www.irs.ustreas.gov). Once you know how much you will need to pay, you can decide whether to make estimated payments or ask your boss to boost your withholding.

DOWN WITH WITHHOLDING. Speaking of withholding, it's a good bet that too much, not too little, is being plucked from your paycheck each month. The average refund was $1,342 this past spring. You can begin receiving installments on next year 's refund by changing the W-4 form that's on file with your employer. The instructions will help you match withholding to what you'll really owe for 1998. For more detailed help, get a copy of Publication 919, Is My Withholding Correct for 1998?, from the IRS.

June brides and grooms should check out the publication, too, lest the marriage-tax penalty give them a fright at year-end. And June grads with new jobs may benefit from "part-year withholding" if their companies offer it. That can put more money in your pocket during the first months on a job rather than building toward a big refund next spring.

MIND YOUR CREDITS AND DEDUCTIONS. You should also cut withholding now if you qualify for any of the tax credits or deductions that start this year.

First of all, if you have young children, drop this article and give each of them a $400 hug. That's what the new child tax credit is worth for each of your dependents under age 17. The credits begin to evaporate for couples whose adjusted gross income exceeds $110,000 and singles who make more than $75,000.

Older kids can cut your tax liability if you're paying their college bills. The Lifetime Learning credit, which becomes available July 1, covers $1,000 of tuition expenses--20% of the first $5,000 in payments--incurred by a taxpayer's dependent for college, grad school or job-related classes. This is a one-per-family credit. But you don't have to have children in college: Tuition for you or your spouse also counts.