So a trick my coworkers will do sometimes is go ‘exempt’ on their federal witholding (I think) for a span of time, then revert it back to normal. The idea is that if they work crazy overtime, they get taxed at a higher bracket, the IRS hangs on to this money, but sometimes, especially if you don’t have a lot of deductions/are single, it seems like you don’t necessarily get the excess amount back at the end of the year. So they will go exempt and basically try to ‘break even’ at tax time.
Next year this time will be crazy for me. I’ll have just gotten married, and we’ll be settling in a house that we will be subletting. My fiancee will be in grad school, possibly working part-time. The 4th quarter of the year (Oct-Dec) for us is a good period to earn overtime; there are 3 paid holidays (Thanksgiving, Xmas day, New Years day) and a lot of high seniority people book off vacations, which means they tend to be shorthanded allowing us to work our days off.
A coworker suggested I go exempt for 3 months, work all my days off- 90+ days straight :eek: plus the 3 holidays, then revert back to normal afteward. I’d hang on to much more of the money at the time, when it will be the most critical for us, and ideally filing jointly (since we’re married at that point) combined with deductions for my fiancee being in school/having much less income from not working the entire year will HOPEFULLY having us break even at the end of the year. In theory.
I help people with back tax problems (folks whose paychecks and bank accounts are being levied, houses are being seized, stuff like that) and I can tell you that 99% of our clients say the same thing:
“Well, my coworkers told me to go exempt for a while, you know? So I did. But then I never changed it back because I needed that money.” Cut to 4 years later and they owe the IRS $40k they can’t pay.
Seriously. I hear people say this every. single. day. My advice? Don’t do it. It’s too easy to not change it back and then you’re going to be fucked. I mean, I’d like to take your money from you to fix your tax problem and all, but it’s probably best if you don’t create a problem to start with :). I guess if you insist on it, but make quarterly estimated payments, you MIGHT be ok. . . but I still wouldn’t recommend it.
There is something else you should know: if the IRS catches wind that you’re intentionally going exempt needlessly, they can send a letter to your employer that forces you down to zero. Once that happens, there is literally nothing that can be done to override their order. Granted, if you’ve never had tax problems before, this is unlikely to happen— but it happens to my clients all the time. And it sucks.
Your coworkers seem to think the rate of a particular tax bracket applies to their entire income. This is a common misconception. I’ll use the 25% tax bracket as an example, which in 2010 applies to income from $34,001 to $82,400 for a single individual. If you are in that income bracket your entire income is not taxed at 25%. Only the amount of money you make that is above $34,000 is taxed at 25%, plus $4,681.25, which corresponds to the cumulative tax of the 10% and 15% brackets*. If you make $82,401, therefore entering the 28% bracket, your tax will increase by 28 cents.
Changing your withholding will not alter the amount of tax you owe at the end of the year - the only effect will be a larger paycheck during the exempt period, of which you’ll still want to put some aside to avoid a big tax bill that you have trouble paying.
10% of $8,375 + 15% of $25,625 ($34,000-$8,375) = $4,681.25
Right - it’s basically just getting Uncle Sam to give you a short term loan (or, more accurately, not giving Uncle Sam a short term loan). If you’re the kind of person who’s really good with money and can set up your withholding so you’ll break even (or keep enough in the bank to pay whatever you owe) it’s a good idea.
If you’re like me, it’s a really horrible idea, and you’ll be calling Diosa for help around April 20th.
However, I think your coworkers are referring to a situation that has not yet been explained. If you have a significantly higher income one month (e.g. because of overtime), the payroll system does not know that it is an anomaly for that one month. It will assume that you make that amount of money every month and tax you accordingly. Hence you can be pushed into a higher tax bracket than you “should”.
To give an example let us say that you are a single person earning $60k after deductions per year as your base. This puts you in the 25% tax bracket. However, let us say that in the first month of the year you earn a $5k bonus, which is a one-off thing. Your total for the year will be $65k. This still leaves you in the 25% tax bracket. However, when your first month’s withholding is calculated, the system will see that you have made $10k and assume that we will therefore earn $120k for the year and therefore some of your monthly pay will be withheld at 28%
So you will be overtaxed initially. This will come out in the wash at the end of the year - you only owe the tax on the actual total amount earned in the year. But you may have had more withheld than necessary and will therefore get a bigger refund. You can avoid this by fiddling about with your withholding, but that is generally a bad idea for reasons already stated by other posters.
You must work with the same tax geniuses my wife does. She played that game last tax year with the 9 deductions one pay period with a lot of overtime and switching back and forth trying to game the tax withholdings.
Trouble is at the end of the year we didn’t have any extra deductions other than our normal 2, that might have allowed us to keep some, and got a $3000 tax bill. Which we have spent this year paying back. All. Fucking. Year.
I don’t really understand. Is this scheme to avoid waiting until the end of the year to get overpaid taxes refunded? Is that typically a large enough sum to waste time even thinking about this? I ask because I’ve only ever gotten a refund when there’s been a lump sum dispersal (e.g. recent stimulus “refund”). I usually have to pay the feds a bit of money each March.
A much better strategy is to figure out what your total schedule A deductions will be for the year, and claim the number of exemptions required to reduce your withholding accordingly. It still leaves bonuses and overtime overtaxed a bit, but you won’t end up with a 3K tax bill.
For example, my wife and I have 2 kids, a 401k, and a mortgage. According to the W-2, we should only file 4 exemptions, I think, but instead I file it with 8, and we get more money each paycheck and still end up with a moderate tax return at the end of the year of about $1000. If we didn’t do this, we would end up with a smaller paycheck and a 3K or more return.
I could up our deductions a little more, but my wife is self employed, and I like having a cushion there to cover her self-employment tax.
The way it works is like this, say you are single and you fill out your W-4 tax withholding form that you give to your employer claiming your 1 real deduction. Single- 1, normally that is what you should have.
Many employers allow you to change this W-4 at any time. So, you work a lot of overtime during a particular pay period and you change your W-4 to 9 deductions for that period, or exempt, instead of 1 to keep from losing such a big chunk to tax withholding. You end up getting a whopper of a paycheck. instead of having what should have been withheld to cover your estimated taxes at year end.
And then you change it back to 1 deduction. You know you haven’t really had enough taxes withheld to cover the amount you earned during that pay period, but hey, so what, your refund that you usually get each year will just be a little smaller, you think. And boy it sure would be nice to have that big pay day next week because we are going camping, or Christmas shopping, or what ever the hell.
Do it a couple times and that refund you usually get each year turns into a bill, can be a big bill, can be an OMG! WTF! bill if you do it too often or fail to change back to the proper number of withholding deductions.