Tax withholding strategy

[gobermitcheese]

• money.msn.com/tax-planning/why-i-hate-income-tax-refunds-schnepper.aspx
  
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This article got me thinking if it would be a good idea to withhold little or no tax for the first 9 months of the year and then withhold the amount of my previous years liability over the final three months. This is aparently legal you would benefit from holding your money longer. My question is, is this legal? Is it worth it? How would you go about it?

[commentator]

Several honest tax pros, myself included, disagree with Schnepper's strategy. I believe it is illegal because it requires that the employee to knowingly complete a false form W-4, then sign it just below this statement. "Under penalties of perjury, I declare that I have examined this certificate and to the best of my knowledge and belief, it is true, correct, and complete."

Edited to add: As an employer I wouldn't think much of an employee who tried this dodge.

Edited to correct misspelling of name.

[haapai]

This message has been deleted.

[gooddecisions]

"Edited to add: As an employer I wouldn't think much of an employee who tried this dodge."

What exactly is the employee dodging that would make you not think much of them? They are still paying their tax liability for the year.

[formerexpat]

Several honest tax pros, myself included, disagree with Schneppner's strategy. I believe it is illegal because it requires that the employee to knowingly complete a false form W-4, then sign it just below this statement. "Under penalties of perjury, I declare that I have examined this certificate and to the best of my knowledge and belief, it is true, correct, and complete."

I fill out a W4 every year with 50 exemptions - yes, 50. I then withhold the correct federal dollar amount. I withhold a lower amount in the first part of the year and then a higher amount later in the year after I've exceeded the SS threshold, so that my net income is just about the same for every pay of the year.

The form, to the best of my knowledge is correct. I'm withholding the correct amount of taxes from my income. In fact, I'm regularly within a couple hundred dollars every year once my taxes are filed, so I'm doing something right.

"Edited to add: As an employer I wouldn't think much of an employee who tried this dodge."

Because you know all of your employees tax situation well enough to know what their tax liability is each year? So, a person shouldn't claim a higher exemption to get the child tax credit in their pay instead of in a refund when they file their taxes? Get real.

[haapai]

There are two practical problems with that strategy.

The first is coming up with a mechanism to get the underwithheld amount into a vehicle with a better return with minimal leakage. It's not hard to find a vehicle with a better return. The hard part is getting all of the underwithheld amount into that vehicle without increasing consumption. A very small increase in consumption will have a dramatic effect on the returns possible using this strategy.

The second problem is that you have to use payroll withholding to reverse the underwithholding. What if you lose your payroll job before reversing the underwithholding? If the underwithholding is severe enough, you may still owe the IRS a substantial amount and miss the safe harbor unless you have an employed spouse whose withholding can be adjusted. A check written to the IRS, even if submitted the moment that you lose your job and well before the end of the year, will not receive the same treatment as payments made through payroll withholding and the evenness of your tax payments may be scrutinized.

[Deleted]

My old boss, the CFO who ran payroll, used to do this for himself. The last handful of checks during the year were zero checks for him because he was withholding all of his liability in those checks.

[phil5185]

not hard to find a vehicle with a better return. The hard part is getting all of the underwithheld amount into that vehicle without increasing consumption.

In my case, it is already there - it is in a mutual fund and I leave it there until I pull it out for Tax Day.

If the underwithholding is severe enough, you may still owe the IRS a substantial amount and miss the safe harbor

Yes. But it isn't a big deal, the penalty is 4% of the owed amount exceeding the $1000 grace, and only for the period that you were underwithheld.
Eg, suppose you failed to meet safe harbor and your year-end bill $2500. The IRS calculates 4% of $1500 for the 'late' period, say it was for Q4. So your fine is 4% of $1500 for 1/4 yr, ie $15. And they do the math and send you a bill for it in about Sept or Oct. If I recall, there is a minimum threshold that the IRS doesn't bother with, it used to be about $25, it may be $100 now, not sure.

[haapai]

Wouldn't it be a somewhat larger penalty? The way that I see it, you'd be paying late on income earned in the first and second quarters and possibly the third, depending on when you sent them a quarterly tax payment that squared you up.

But you're right about the fine being relatively small. Thanks for telling me about that.

[phil5185]

The way that I see it, you'd be paying late on income earned in the first and second quarters and possibly the third, depending on when you sent them a quarterly tax payment that squared you up.

Yes - It depends on when you booked the income, if you sold a block of stock in Q4, the 4% would only apply to Q4. But you're right, if you have a steady income stream, they calculate how much you were 'light' for each quarter - say an average of $100 during Q1, an average of $300 in Q2, $500 in Q3, $1500 in Q4 - and apply that 4% for the prorated part of the year that was affected.

[haapai]

Is it worth it?

It's probably worth it, but determining how much it is worth is quite complicated. It's not as simple as subtracting one rate of return from the other. You have to pay attention to the fact that the underwithheld amount will only be earning a return for part of the year. It goes into the return yielding vehicle quite slowly and then is yanked back out. The amount that you gain using this strategy will be considerably less than the underwithheld amount times the annual rate of return of the investment vehicle.

[gobermitcheese]

Several honest tax pros, myself included, disagree with Schneppner's strategy. I believe it is illegal because it requires that the employee to knowingly complete a false form W-4, then sign it just below this statement. "Under penalties of perjury, I declare that I have examined this certificate and to the best of my knowledge and belief, it is true, correct, and complete."

Maybe I don't understand the whole allowances thing but cant you basically claim whatever you want. It will not change the amount owed at tax time and this is true as long as you have enough withheld to avoid penalties. I don't understand how claiming more allowances is necessarily dishonest.

[cronewitch]

I do my own paycheck and withhold vurtually nothing the first 10 months. So far this year I withheld 150 even because I withheld 20% of my sick payout then rounded it on another check. My tax for the year will be about 2,500 because I plan my taxes. I withhold a lot of money the first half for 401K so if I lost a job in the first half of the year I would have no tax for the year. I would take another job to at least make something the second half and withhold enough even if I had to be a temp and withhold 100%. Unless I was fired I would write my own paycheck and could put my last check all to 401K and withholding. I have over 500 hours vacation so my last check would be over 10K and withholding over 2K so I would have plenty paid in anyhow.

[commentator]

Apr 30, 2011 20:52:58 GMT -5 gobermitcheese said:

Several honest tax pros, myself included, disagree with Schneppner's strategy. I believe it is illegal because it requires that the employee to knowingly complete a false form W-4, then sign it just below this statement. "Under penalties of perjury, I declare that I have examined this certificate and to the best of my knowledge and belief, it is true, correct, and complete."

Maybe I don't understand the whole allowances thing but cant you basically claim whatever you want. It will not change the amount owed at tax time and this is true as long as you have enough withheld to avoid penalties. I don't understand how claiming more allowances is necessarily dishonest.

Huh? You don't understand how lying is dishonest?

It's clear that you aren't the only poster in this thread who is quite comfortable with perjuring themselves. So be it.

And yes, if an employee of mine submitted a W-4 that resulted in zero withholding early in the year, then changed to a relatively large withholding for the last several pay periods, then I would have a pretty good idea what was going on. Maybe that employee would get a counseling session or maybe that employee would be shown the door.

[gobermitcheese]

I still don't understand what is dishonest about paying the minimum amount of withholding legally required. My understanding is that you can claim any amount of allowances you like to bring your withholding down to the amount required. I am not convinced that this would involve lying or be illegal. I am an honest person and would never knowingly commit tax fraud but I am not sure this is dishonest.

[gobermitcheese]

Several honest tax pros, myself included, disagree with Schneppner's strategy. I believe it is illegal because it requires that the employee to knowingly complete a false form W-4, then sign it just below this statement. "Under penalties of perjury, I declare that I have examined this certificate and to the best of my knowledge and belief, it is true, correct, and complete."

I actually went back and read a W-4 form and it looks like you are right. To those that actually claim additional allowance over what they are entitled to where on the form do you claim them?

[mwcpa]

remitting the legal minimum is always the best strategy, but the intentional under-withholding can cause problems (if one claims a number of exemptions so that in April they are even steven, that's great planning and 100% legal, but if some claims 99 exemptions so tax withholding is zero and they know it is wrong that can be problematic, even of they change the W-4 late in the year to over-withhold or make estimated income tax payments), forgetting all of the shock for most who owe in April instead of getting the huge refund... many have bought into the concept (thanks partially to huge misunderstanding of the tax law and advertising by the big box tax preparation chain stores) that the bigger the tax refund the better.... they fail to look at the total tax line, which is really the cost of tax....most people are not smart with money, if the net paycheck 500 or 750, it's all spent....

the issue with intentional under-withholding is as follows, from IRS publication 919....

"You can claim only the number of allowances to which you are entitled. To see if you can decrease your withholding by increasing your allowances, see the Form W-4 instructions and the rest of this publication. "

"Generally, the amount your employer withholds for federal income tax must be based on your Form W-4. However, whether you are entitled to claim exempt status or a certain number of withholding allowances is subject to review by the IRS. If the IRS determines that you cannot claim more than a specified number of withholding allowances or claim a complete exemption from withholding, the IRS will issue a notice of the maximum number of withholding allowances permitted (commonly referred to as a “lock-in letter”) to both you and your employer. " - I personally have seen people get "stuck" with this when they intentionally underwithhold... one client was forced to claim single zero because they habitually claimed single 9 and owed every year and requested an installment agreement every year, IRS said enough is enough and they would not longer finance the persons lifestyle.

right on the form W-4, on top of the "under penalties of perjury" statement that you sign... the form clearly states on top "whether you are entitled to claim a number of allowances or exemptions from withholding is subject to review by the IRS. Your employer may be required to send a copy of this form to the IRS." It was not too long ago that employers were required to send W-4s to the IRS when claimed exemptions exceeded certain thresholds, that rule could always come back and then forget about this strategy to time the payment of withholding

[MN-Investor]

And yes, if an employee of mine submitted a W-4 that resulted in zero withholding early in the year, then changed to a relatively large withholding for the last several pay periods, then I would have a pretty good idea what was going on. Maybe that employee would get a counseling session or maybe that employee would be shown the door.

Leave the tax enforcement to the IRS. For all you know, the employee's spouse's retail business produces large losses in the first 9 months of the year before large 4th quarter sales and they truly don't owe taxes until that final quarter. Unless you know their complete tax picture, including medical expenses, mortgage interest, and charitable deductions, keep your judgements to yourself.

[commentator]

In general, I will not have dishonest employees working for me.

In particular, I cannot afford to have tax cheats working for me even if I thought cheating on taxes was ok (which I do not).

[Deleted]

May 1, 2011 15:50:17 GMT -5 @commentator said:

In general, I will not have dishonest employees working for me.

In particular, I cannot afford to have tax cheats working for me even if I thought cheating on taxes was ok (which I do not).

How would you know they are being dishonest unless you have their total financial situation in front of you. Do you file their taxes?

Like the other poster said: leave the tax enforcement to the IRS.

[phil5185]

In particular, I cannot afford to have tax cheats working for me even if I thought cheating on taxes was ok (which I do not).

You may be confusing "allowances" with "deductions". Deductions go on your tax return and affect your tax bill (your tax liability).

Allowances, OTOH, go on your W4 Form to adjust your withholding. The two numbers are not the same - there is a list of acceptable 'allowances' that you use to adjust your withholding - workers with second jobs, people who work only part of the year, landlords who have both rental income & W2 income, etc. When you sign/swear the form, you are stating that you are using the proper number of allowances - it has nothing to do with the exemptions on your tax return.

[commentator]

The OP asked a question. I answered it. Most of the people posting on this thread don't like the answer. That's tough.

You want to lie, cheat and steal? Go right ahead but don't expect aid or comfort from honest people when you do.

[Deleted]

I worked for a small consulting firm in the late 90s and the bookkeeping was done by the old guy who founded the place. I remember one year I went to him around October and said that I was overwithheld and my calculations showed that I'd already paid in enough to meet my liability. I asked him to withhold zero for November and December. He's one of the most straight-up and honest guys I've ever known but he agreed- except that he insisted on withholding something like 5% just so it didn't look bad to the IRS. I agreed. Boy, those were the good old days. I didn't even have to fill out a revised W-4.

[formerexpat]

You want to lie, cheat and steal?

Where has anyone stated that? It's stupid to assume you know enough about everyone's tax situation to determine whether they are withholding too much or too little.

In particular, many that bought a house a couple years back owed little or maybe no federal taxes. It was perfectly legal to under withhold during the year and no one perjured themselves by altering their W4. Their withholding was complete and accurate - for their tax situation.

I'll trust the advice I got from the big 4 about the topic.

[Deleted]

May 1, 2011 18:20:03 GMT -5 formerexpat said:

In particular, many that bought a house a couple years back owed little or maybe no federal taxes. It was perfectly legal to under withhold during the year and no one perjured themselves by altering their W4. Their withholding was complete and accurate - for their tax situation.

I've declared 15 withholding allowances for Federal purposes and gotten refunds. I was single at the time, with one dependent child and a big mortgage and exorbitant property taxes.

If commentator considers that lying, cheating and stealing, well, I guess I'd rather not work for him.

[commentator]

Formerexpat and athena53, if they have read the posts in this thread, know exactly what I'm talking about.

In case they haven't read this thread, I'm talking about completing a fraudulent W-4 early in the year to deliberately underwithhold income taxes, then completing another W-4 late in the year to make up the difference. Doing so is lying (perjury, actually, which is a form of obstruction of justice), cheating (not following the rules or, in this case, the law) and stealing (from honest tax payers).

Providing examples that clearly are not fraudulent behavior doesn't excuse the ones (including some posting in this thread) who advocate or practice fraudulent, illegal conduct.

[commentator]

May 1, 2011 18:00:34 GMT -5 @athena53 said:

I didn't even have to fill out a revised W-4.

Your straight-up, honest old guy is lucky the IRS didn't ask to see employee W-4s for that year. If they had, he might still have been straight-up and honest, but not so lucky.