Income Tax Question - Better to claim exempt then pay later?

[NeutralNovice]

For all of my working life so far, I have always claimed Single-0-0, thus, I have no exemptions whenever I receive my paycheck. I always get a refund after I file so basically, the government is the one holding my money, to which I earn no interest.

Can someone explain to me if this scenario makes sense and if it would end up working out more over the long run?

Scenario:

If I claim exempt on my checks all year and pay no Federal Income Tax and then simply put what I would have been taxed into a high yield savings account without touching the money for a whole year, would I end up getting more money overall since all I would be paying is my exact tax liability with the leftovers being all mine?

I mean, I would assume so, since the interest would be the increased difference; however, are there any caveats to claiming exempt? For example, at the end of the year, will I be somehow liable for more taxes than if I claimed 0?

A risk that I know of already, at least, would be the fact that since the money is already mine, that I might get tempted to dip into that "tax fund" and, thus, cause me issues at the end of the year.

Ugh, I wish I could me more concise and articulate on this matter--I hope my explanation of the scenario isn't confusing/badly worded.

 

[Praying Colonel]

For all of my working life so far, I have always claimed Single-0-0, thus, I have no exemptions whenever I receive my paycheck. I always get a refund after I file so basically, the government is the one holding my money, to which I earn no interest.

Can someone explain to me if this scenario makes sense and if it would end up working out more over the long run?

Scenario:

If I claim exempt on my checks all year and pay no Federal Income Tax and then simply put what I would have been taxed into a high yield savings account without touching the money for a whole year, would I end up getting more money overall since all I would be paying is my exact tax liability with the leftovers being all mine?

I mean, I would assume so, since the interest would be the increased difference; however, are there any caveats to claiming exempt? For example, at the end of the year, will I be somehow liable for more taxes than if I claimed 0?

A risk that I know of already, at least, would be the fact that since the money is already mine, that I might get tempted to dip into that "tax fund" and, thus, cause me issues at the end of the year.

Ugh, I wish I could me more concise and articulate on this matter--I hope my explanation of the scenario isn't confusing/badly worded.

I'm not sure I'm getting your question, but I try to set up my withholdings so I don't have to pay anything at tax time but I'm not getting a huge refund, either.

Some people use the huge refund as a kind of forced savings program. Personally, I feel like I can manage my own savings just fine, and the huge refund means I'm giving the government an interest-free loan on my money. YMMV.

You can use the withholdings calculator (which is currently down, unfortunately) on the IRS website to compute your withholdings.

 

[soccerdad72]

Theoretically, you should always strive to have your tax return work out to zero each year, thus paying what you owe throughout the year and not any extra.

But, if you're someone who needs a tax return as a forced savings plan, then yes, continue to withhold as you've been doing so. But like you said, in that scenario, you're essentially giving the government your money to hold onto.

 

[daughtersrus]

For all of my working life so far, I have always claimed Single-0-0, thus, I have no exemptions whenever I receive my paycheck. I always get a refund after I file so basically, the government is the one holding my money, to which I earn no interest.

Can someone explain to me if this scenario makes sense and if it would end up working out more over the long run?

Scenario:

If I claim exempt on my checks all year and pay no Federal Income Tax and then simply put what I would have been taxed into a high yield savings account without touching the money for a whole year, would I end up getting more money overall since all I would be paying is my exact tax liability with the leftovers being all mine?

I mean, I would assume so, since the interest would be the increased difference; however, are there any caveats to claiming exempt? For example, at the end of the year, will I be somehow liable for more taxes than if I claimed 0?

A risk that I know of already, at least, would be the fact that since the money is already mine, that I might get tempted to dip into that "tax fund" and, thus, cause me issues at the end of the year.

Ugh, I wish I could me more concise and articulate on this matter--I hope my explanation of the scenario isn't confusing/badly worded.

I'm not a tax expert but I don't think that you can do that. You have to pay during the year unless you're self-employed and then you have to pay quarterly.

If everyone held their money until April to send it to the taxing bodies, we'd probably be in worse shape than we are now.

 

[threeboysmom]

From what I've read in the past (and my mind is fuzzy on this), you have to pay tax at least quarterly or you will get hit with a fine.

I'm in the same boat as you. I claimed 0 last year and now am expecting a refund. I need to play around with my withholding in 2013 so that I come pretty darn close to not owing or getting a refund - I'd rather not give the IRS anymore than I have to, lol. I can save just fine on my own.

 

[BlovesC]

The more exemptions you claim, the less money you'll have taken out of each paycheck as federal tax withholding. That means more money in your pocket, and you can certainly put it into an interest-earning account and wind up ahead at the end of the year. But, like you said, when you file your return, your withholding will fall short of paying your tax bill, and then you'll have to submit a payment with your return (which, if not made by April 15th, WILL incur penalties).

As to which is better...it's kind of a matter of personal preference, I guess. You don't earn interest on the money the government is 'holding' for you, like you said. But if you drastically increase your exemptions to have more 'take home' pay each week, you might be stuck with a heavy bill at the end of the year, so hopefully you've kept some of that excess aside in savings to pay it.

 

[StitchesGr8Fan]

Why don't you just take the time to use a withholding calculator to figure out how to adjust your w-4 so you neither owe nor get a refund at the end of the year. The govt won't let you pay once a year. And they would charge you taxes on the interest you would earn on the account.

 

[NeutralNovice]

@daughtersrus
I am able to claim exempt from Fed Income Taxes; however, I would still have to pay other withholding like SDI, SSI, etc.


Basically, what I am trying to do is this--hypothetically:

For this scenario, imagine that the only tax that exists is the Federal Income Tax.

Hypothetical #1
Claim: No Exemptions
Gross Income: $100,000
Withholding Rate: 25% ($25,000)
Calculated Tax Liability Rate: 15% ($15,000)
Expected Refund: $10,000
Overall Earnings After Tax: $85,000

Hypothetical #2
Claim: Exempt
Gross Income: $100,000
Withholding Rate: 0%
Calculated Tax Liability Rate: 15% ($15,000)
Expected to Owe: $15,000
Overall Earnings After Tax: $85,000
>>>Instead of the government holding my money and not paying interest, I am getting all the money and will put 15% of each check into a Savings Account that I won't touch.

So using a "Regular Deposit Savings Interest Calculator," I would deposit about $960 into account for each check or $1920/month, without touching it. Current APY is 1.00%. So at the end of the year, the interest accrued would be about $242.

Wow, so after all that, I would only make $242--and that's assuming I make $100k, which I don't LOL. Either way though, every penny counts--I guess I am just worried about the consequences if I claim exempt then just pay my actual tax liability in one lump sum.

 

[Cheshire Figment]

You cannot do that.

You are only allowed to claim "Exempt" on a W-4 if your previous year's actual tax was zero and you anticipate that the current year tax will also be zero. This is right on the instructions for the W-4.

If you claim ten or more exemptions on a W-4 your employer is required to send a copy of your W-4 to the IRS. They will review your prior year returns and can notify your employer of the maximum allowable exemptions that they can process for you.

In addition, if you are underwithheld by $1,000 or more you are also subject to penalties for underpayment of Estimated Taxes. (NeutralNovice please note this)

Mike (CPA Retired but still doing taxes professionally)

 

[soccerdad72]

@daughtersrus
I am able to claim exempt from Fed Income Taxes; however, I would still have to pay other withholding like SDI, SSI, etc.

The only way you can claim fully exempt is if you qualify (from the W-4 form):

I claim exemption from withholding for 2013, and I certify that I meet both of the following conditions for exemption.

• Last year I had a right to a refund of all federal income tax withheld because I had no tax liability, and

• This year I expect a refund of all federal income tax withheld because I expect to have no tax liability.

 

[NeutralNovice]

From what I've read in the past (and my mind is fuzzy on this), you have to pay tax at least quarterly or you will get hit with a fine.

I'm in the same boat as you. I claimed 0 last year and now am expecting a refund. I need to play around with my withholding in 2013 so that I come pretty darn close to not owing or getting a refund - I'd rather not give the IRS anymore than I have to, lol. I can save just fine on my own.

Anyone able to verify a requirement to pay taxes on a quarterly basis?



Thank you everyone for your replies and help!

 

[NeutralNovice]

You cannot do that.

You are only allowed to claim "Exempt" on a W-4 if your previous year's actual tax was zero and you anticipate that the current year tax will also be zero. This is right on the instructions for the W-4.

If you claim ten or more exemptions on a W-4 your employer is required to send a copy of your W-4 to the IRS. They will review your prior year returns and can notify your employer of the maximum allowable exemptions that they can process for you.

In addition, if you are underwithheld by $1,000 or more you are also subject to penalties for underpayment of Estimated Taxes. (NeutralNovice please note this)

Mike (CPA Retired but still doing taxes professionally)

The only way you can claim fully exempt is if you qualify (from the W-4 form):

Thanks for the info on that! It'll probably be easier to just claim 0 as I always have LOL.

 

[mrspaha]

With taxes that high, you will get a huge penalty for underwithholding. You have to pay in during the year at minimum the amount of your tax liability from the previous year.

 

[soccerdad72]

Anyone able to verify a requirement to pay taxes on a quarterly basis?

As a taxpayer who pays quarterly, I can vouch that if your payments during the year (either through withholdings or quarterly payments) don't meet certain thresholds by the end of the year, you will be subject to penalties when you file your tax return.

We were off by just a few dollars one quarter and we did end up having to pay a penalty.

 

[soccerdad72]

Thanks for the info on that! It'll probably be easier to just claim 0 as I always have LOL.

It's not an 'all or none' decision. You can claim exemptions, just not fully exempt. The more exemptions you claim, the less that is withheld from each paycheck.

 

[sam_gordon]

@daughtersrus
I am able to claim exempt from Fed Income Taxes; however, I would still have to pay other withholding like SDI, SSI, etc.


Basically, what I am trying to do is this--hypothetically:

For this scenario, imagine that the only tax that exists is the Federal Income Tax.

Hypothetical #1
Claim: No Exemptions
Gross Income: $100,000
Withholding Rate: 25% ($25,000)
Calculated Tax Liability Rate: 15% ($15,000)
Expected Refund: $10,000
Overall Earnings After Tax: $85,000

Hypothetical #2
Claim: Exempt
Gross Income: $100,000
Withholding Rate: 0%
Calculated Tax Liability Rate: 15% ($15,000)
Expected to Owe: $15,000
Overall Earnings After Tax: $85,000
>>>Instead of the government holding my money and not paying interest, I am getting all the money and will put 15% of each check into a Savings Account that I won't touch.

So using a "Regular Deposit Savings Interest Calculator," I would deposit about $960 into account for each check or $1920/month, without touching it. Current APY is 1.00%. So at the end of the year, the interest accrued would be about $242.

Wow, so after all that, I would only make $242--and that's assuming I make $100k, which I don't LOL. Either way though, every penny counts--I guess I am just worried about the consequences if I claim exempt then just pay my actual tax liability in one lump sum.

What it sounds like you need to do is to change your withholding so that you get back $833 ($10K/12 months) more each month. So instead of claiming 0 dependents, throw some dependents in there. Your HR person can help you figure out how much will get you close to the $0 mark come April. And if you look at the W-4 form, you're claiming "allowances", NOT "exemptions".

 

[clutter]

For all of my working life so far, I have always claimed Single-0-0, thus, I have no exemptions whenever I receive my paycheck. I always get a refund after I file so basically, the government is the one holding my money, to which I earn no interest.

Can someone explain to me if this scenario makes sense and if it would end up working out more over the long run?

Scenario:

If I claim exempt on my checks all year and pay no Federal Income Tax and then simply put what I would have been taxed into a high yield savings account without touching the money for a whole year, would I end up getting more money overall since all I would be paying is my exact tax liability with the leftovers being all mine?

I mean, I would assume so, since the interest would be the increased difference; however, are there any caveats to claiming exempt? For example, at the end of the year, will I be somehow liable for more taxes than if I claimed 0?

A risk that I know of already, at least, would be the fact that since the money is already mine, that I might get tempted to dip into that "tax fund" and, thus, cause me issues at the end of the year.

Ugh, I wish I could me more concise and articulate on this matter--I hope my explanation of the scenario isn't confusing/badly worded.

You will owe interest and penalties for not paying enough during each calendar quarter.

From a practical standpoint, the IRS requires additional filings from employers to verify exempt status, as well as any claims over a certain number of exemptions.

Then there is the risk of spending the funds that you are setting aside for taxes. You do not want the IRS to be a creditor. That's setting you up for failure.

FWIW, an old roommate had done this back when there were less obstacles to doing so. It took her YEARS to get out of debt with the IRS. Plus, she did end up adjusting to the tax-less lifestyle. It was really hard to adjust her life back to not just withholding, but the additional debt.

 

[NeutralNovice]

You will owe interest and penalties for not paying enough during each calendar quarter.

From a practical standpoint, the IRS requires additional filings from employers to verify exempt status, as well as any claims over a certain number of exemptions.

Then there is the risk of spending the funds that you are setting aside for taxes. You do not want the IRS to be a creditor. That's setting you up for failure.

FWIW, an old roommate had done this back when there were less obstacles to doing so. It took her YEARS to get out of debt with the IRS. Plus, she did end up adjusting to the tax-less lifestyle. It was really hard to adjust her life back to not just withholding, but the additional debt.

Wow, you all are so helpful--replies are so quick that by the time I'm about to ask another question, you guys have already answered it. Thank you so much!

The reason why I thought of this scenario was because there was someone else at my job who accidentally forgot to reset her claim status from Exempt to 0. I told her she's pretty much screwed because she didn't pay ANY FIC last year AND she spent all or most of her earnings. I only thought she would simply pay whatever her tax liability is when she calculates it--which is why I thought of the whole "getting interest" thing. Now that I know there are penalties, I feel really bad for her because I don't think she knows that there will be any penalties. Eek.

If anyone knows, just how steep are these penalties?

 

[clutter]

It all depends on the liability and the timing of any payments. However, I wouldn't worry about it if I was you, as it is her problem, not yours. She should however, file her taxes asap and pay something. The IRS will set up a payment plan if need be. However, she is in for a shock as she will be living life post-deductions and with additional debt. She will have a big lifestyle change.

I'm assuming she will be filing a 1040EZ since she sounds young enough to not have a complicated return. I think that if she trys a program like Turbotax (which you can usually find for free with a 1040EZ), they can estimate interest and penalties for her, but generally the IRS will bill you for them after you file.

You're in CA, so there will be state withholding issues as well, I assume.

 

[NeutralNovice]

It all depends on the liability and the timing of any payments. However, I wouldn't worry about it if I was you, as it is her problem, not yours. She should however, file her taxes asap and pay something. The IRS will set up a payment plan if need be. However, she is in for a shock as she will be living life post-deductions and with additional debt. She will have a big lifestyle change.

I'm assuming she will be filing a 1040EZ since she sounds young enough to not have a complicated return. I think that if she trys a program like Turbotax (which you can usually find for free with a 1040EZ), they can estimate interest and penalties for her, but generally the IRS will bill you for them after you file.

You're in CA, so there will be state withholding issues as well, I assume.

Thanks! I'm a bit worried for her because she's a friend but at the same time, she's also an example why I don't mess with exemptions in the first place. Heck, I'm the only one in the company that contributes to a Roth 401k rather than regular--I'd prefer to reduce my tax burden when I retire.

When I see her this week, I'll let her know of the info I found from you guys--she wont like it, but it's the truth.

Luckily, her exempt option did not include state withholding so she shouldn't be receiving penalties from them as well.