Modify W-4 to help front-load investments and back-load tax withholdings?

[jimmylomax]

I've seen some similar threads here and on reddit, but I haven't seen a clear answer other than what seems to be sheer speculation (just a link to the long, complicated tax code I'm not ready to decipher just yet)... looking at you MDM!
I want to essentially defer paying my income taxes as late in the tax year as possible. Here is a scenario:
- January 1st, change W4 exemptions to 99 to force no withholdings. Heavily contribute to pretax investments to help hit my AGI and 15% marginal-bracket targets: HSA, 457(b), 403(b), contrib some to 401k as needed. Put rest into Roth 401k/IRA.
- Octoberish, after hitting investment account targets, change W4 exemptions as needed to get to safe target total tax withholding number (maybe 100% of estimated tax liability, maybe 90%) before 12/31. (also start saving cash for property taxes)

I've heard the critical milestones are at the end of each quarter - would it be better/acceptable to withhold 1/4 of my annual liability at the end of each quarter? I could just dump the last paycheck each quarter to withholdings.
I've read inputting "99" sends a red flag, but does it really? Does IRS actually review W4 information? would "37" be any better?

[dandarc]

Lots of people do this.  Key is to have a responsive HR/Payroll setup - would suck if you put your change in late in the year only to find that your payroll department takes a month to turn it around.

As far as I know, this is legal - tax withheld from your W-2 earnings is considered to be earned evenly over the year.

[BarkyardBQ]

DW and I have M5 on our W4s, w/ no kids. We front load Jan-Oct, but we don't really change our W4s in October, we chose exceptions that would get us close enough... owing a few hundred bucks each April.

We have no withholding January - October.

[jimmylomax]

Lots of people do this.  Key is to have a responsive HR/Payroll setup - would suck if you put your change in late in the year only to find that your payroll department takes a month to turn it around.

As far as I know, this is legal - tax withheld from your W-2 earnings is considered to be earned evenly over the year.

good good good.

We use ADP and as long as I make a change within first couple days of semi-monthly cycle it will be effective in the current cycle. I tweaked it in for 2016 to see if I could come up with a $10 fed and state refund. (thanks excel1040.com!)

Actually what I've been doing is leaving it at 99 exemptions and then filling in the box to "withhold additional amounts" since I never could get the stupid formula to work perfectly.

[SeattleCPA]

I'm curious to know how much money this optimization saves you each year?  What is your estimate?

This shouldn't save you any money... except that you can earn an extra year's interest or return on the money.

BTW, small business corporations do this regularly by simply doing an annual payroll late in the year. And in that payroll they withhold the perfect amount of tax so they're not overpaying taxes or underpaying taxes.

Example: S corporation owner generates $150K of profit and splits this into (say) $50K of wages, $25K of tax-free benefits, and 75K of distributions. Assume for purposes of this example, that that $50K wages figure is reasonable.

In this scenario, S corp can distribute money to shareholder, pay tax-free fringe benefits through out the year... and then at the end of the year, the S corp can pay an annual payroll where the gross amount equals $50K and then the federal withholding equals the perfect amount.

[jimmylomax]

I'm curious to know how much money this optimization saves you each year?  What is your estimate?

political answer:
Look, there are intangible benefits to understanding the ins and outs of how personal finance and taxes work. There are people every day that come home and plop down on the couch to the local noise with their idiot box. Having the interest to understand how all this stuff works, to me, is invaluable. Having the interest in how things work and being willing to say "I don't know" and "If someone else can do it, I can do it too" has paid amazing dividends in my career so far! (see how I threw the "look" in there... that always gets me thinking. "This guys is totally about to blow smoke up somebody's...")

technical answer:
I didn't do a full present worth analysis, but thinking pretty much as I go: with an annual fed and state tax liability of 11k + year-end property taxes on our cars, house, and rental property at another 11 and then insurance on both properties at around 5k, we're talking about deferring about 27k to the last minute instead of spreading it out as most people do. I'm going to guess and say I'm getting an additional 6 months interest on that 27k each year. At 6.5% avg inflation-adjusted APY, I'd be saving/making $875 per year. 10 years of doing that with interest is $11k. And I learned something too! Dang it's a wonderful life.

[MDM]

I've seen some similar threads here and on reddit, but I haven't seen a clear answer other than what seems to be sheer speculation (just a link to the long, complicated tax code I'm not ready to decipher just yet)... looking at you MDM!

Having the interest to understand how all this stuff works, to me, is invaluable. Having the interest in how things work and being willing to say "I don't know" and "If someone else can do it, I can do it too" has paid amazing dividends in my career so far!

Appears you are close to deciphering it - good luck!

[sokoloff]

I've read inputting "99" sends a red flag, but does it really? Does IRS actually review W4 information? would "37" be any better?

W-4 forms are filed by your employer for 4 years and only sent to the IRS by specific request of the IRS. (so, you should assume, "almost never, and probably only if you have other tax problems") If "37" gets the same mathematical result as "99", there's no particular reason to prefer 99, of course.

W-2 withholdings are treated as withheld evenly throughout the year, so you don't need to fool with balancing quarters if you're a regular employee. (Those making estimated payments don't get this luxury.)

Minor nit: this is not back-loading or changing the timing of your tax liability. It's only changing the date of your withholding.

[hunt2eat]

I do this every year.  If you have predicable income and tax situation its easy to calculate do.  I try to explain it to friends and what not but all I get is blank stares and the "I like my big refund"  "its a savings account for me"

[jimmylomax]

Thanks gang! Good enough for me to forge ahead... consider me at 99 for a while.

Appears you are close to deciphering it - good luck!

Fair enough. I just figured there were probably many people on here that had already been there and done that. (I'm not sure if that was part encouragement, or part "why do you want us to look it up, you do it!") Either way, thanks for the feedback.

I've read inputting "99" sends a red flag, but does it really? Does IRS actually review W4 information? would "37" be any better?

W-4 forms are filed by your employer for 4 years and only sent to the IRS by specific request of the IRS. (so, you should assume, "almost never, and probably only if you have other tax problems") If "37" gets the same mathematical result as "99", there's no particular reason to prefer 99, of course.

W-2 withholdings are treated as withheld evenly throughout the year, so you don't need to fool with balancing quarters if you're a regular employee. (Those making estimated payments don't get this luxury.)

Thanks! I was pretty much already of the mindset, "I'm planning to do this and beg forgiveness later unless someone convinced me not to. I definititely don't want to mess up and get the "lock-in letter" from Sam - more on that below.

What you said completely jives with what I was thinking. You sound quite confident with your answer; Just out of curiousity,  do you work in this field or possibly have any sources I could save to show my parole officer? (the guys at work all seem to think I'm going to jail)

I do this every year.  If you have predicable income and tax situation its easy to calculate do.  I try to explain it to friends and what not but all I get is blank stares and the "I like my big refund"  "its a savings account for me"

Do you come in with a slight refund every year? If not, how far do you take it?

Yep - now the guys at the office know what I'd do in most situations, but they definitely don't understand why I'm like this.
I'm such an OCD optimizer. We still have significant headroom in our pretax accounts. I'll save as hard as it takes such that we can hit  < 110k AGI to keep child tax credits and < 75k taxable income to stay in 15% marginal bracket. Really this mostly means however much we get in bonuses or raises we still live on the same AGI and just invest more or less each year.  I've got it down now such that whatever happens in the year, I've got my tax estimates down to tens of dollars by November. And, to steal from Pete... to me we're living a ridiculously luxurious lifestyle. The guys at work thought I was lying the first few times I told them we hang out in the 15. I get that we're all singing the same song here.


To All,
I'm wondering how far a person could go with this. I know that you can also under-withhold up to 10% each year without paying any penalty or interest , but I believe you can be off by more than the 10% if a few conditions are true - one of which is having had a refund in the previous year (which I've somewhat eluded to and is the reason I targeted a slightly positive return for fy2016.) Now I think we'd be flirting with lock-in letter time if we get ridiculous. Has anybody done this and if so how far have you taken it? I was thinking I'd dip in my toes and try to withhold 91% of my tax liability for fy2017. But then I guess I'd have to wait two more years to take another mile. What say you? My main thought is just that at some number they'll ask for justification and then at the next level we start playing with auditing. As you might have gathered, I have very good records and feel good about my luck in a potential audit situation as I could back up anything I've ever done. While I like to see how much I can make things lean to my advantage, to the best of my knowledge I believe I'm complying with the law.

.....
For posterity - I thought I'd list some of the more useful links I've read:

IRS page indicating they no longer require regular W-4 reportings for "...more than 10 allowances..."
https://www.irs.gov/help-resources/tools-faqs/faqs-for-individuals/frequently-asked-tax-questions-answers/small-business-self-employed-other-business/form-w-4-wage-withholding/form-w-4-wage-withholding-1

IRS page for employers regarding the lock-in letter - which sokoloff paraphrased quite nicely https://www.irs.gov/taxtopics/tc753.html

IRS page which eludes to the fact they no longer collect W-4 data and suggests how they operate. https://www.irs.gov/businesses/small-businesses-self-employed/withholding-compliance-questions-and-answers
"Employers are no longer required to routinely submit Forms W-4 to the IRS.  However, in certain circumstances, the IRS may direct you to submit copies of Forms W-4 for certain employees in order to ensure that the employees have adequate withholding. You are now required to submit the Forms W-4 to IRS only if directed to do so in a written notice or pursuant to specified criteria set forth in future published guidance."

In some clever wording it sounds to me that while they are definitely no longer reviewing W-4s, they may be using some algorithm to compare the actual withheld money they are receiving throughout the year to what they expect to see from the tax payer. but maybe it isn't even that "sophisticated" maybe they really are just looking at the number on the W2 and comparing to the 1040 total tax liability:

"Q2: If an employer no longer has to submit Forms W-4 claiming complete exemption from withholding or claiming more than 10 allowances, how does the IRS determine adequate withholding?
A2: The IRS is making more effective use of information contained in its records along with information reported on Form W-2 wage statements to ensure that employees have enough federal income tax withheld."

https://www.irs.gov/businesses/small-businesses-self-employed/withholding-compliance-questions-and-answers

Some legalese on "false or fraudulent [W-4] information". https://www.law.cornell.edu/uscode/text/26/7205
Shows worst-case fine information. But I'm not really sure what false or fraudulent means in this context. I fully intend on revising the W-4 within the year as well as paying my fair share of taxes. Furthermore, the formulas I'm supposed to use do not take into account my specific tax circumstances such as rental property the fact 70% of my spouse's salary goes into pre-tax retirement accounts.

Here is most of the noise I referred to. I think there is some good signal in there too. https://www.reddit.com/r/personalfinance/comments/mg3ou/i_want_to_claim_99_dependents_on_my_w4_form_so/#bottom-comments

[MDM]

Appears you are close to deciphering it - good luck!

Fair enough. I just figured there were probably many people on here that had already been there and done that. (I'm not sure if that was part encouragement, or part "why do you want us to look it up, you do it!") Either way, thanks for the feedback.

Encouragement.

To All,
I'm wondering how far a person could go with this. I know that you can also under-withhold up to 10% each year without paying any penalty or interest , but I believe you can be off by more than the 10% if a few conditions are true - one of which is having had a refund in the previous year....

Having a refund in the previous year, by itself, has no impact whatsoever.

See Publication 17 (2016), Your Federal Income Tax - "Safe Harbors".  Paraphrasing,

You can use the following general rule as a guide during the year to see if you will have enough withholding, or if you should increase your withholding or make estimated tax payments.
General rule.    In most cases, you must pay estimated tax [will have enough withholding] for 2017 if both [either] of the following apply.

    You expect to owe at least [less than] $1,000 in tax for 2017, after subtracting your withholding and refundable credits.

    You expect your withholding plus your refundable credits to be less than [greater than] the smaller of:

        90% of the tax to be shown on your 2017 tax return, or

        100% of the tax shown on your 2016 tax return (but [If your AGI for 2016 was more than $150,000 ($75,000 if your filing status for 2017 is married filing a separate return), substitute 110% for 100%] ). Your 2016 tax return must cover all 12 months.

[jimmylomax]

Thanks. Consider me encouraged ;)

And thanks for the clarification as well as the paraphrasing to turn the wording around. I look all this withholding stuff up and then lazily neglect to review the other part - shame on me ehh (though I still have quite a bit of time get to the underpayment aspect under control).

So, if I try to simplify and summarize for someone in the 15% bracket filing jointly with similar year-over-year tax liability, and without any significant "Other Taxes" in lines 57-63 and with credits such as child tax credit (i.e. simplify for me), I should plan to shoot for slightly less than the fixed $1000 under-withheld number. And with current tax law, you can do it each and every year without any penalty or other repercussion.
My logic: Tax on 75k before credits is around 10k. @ 90% withholding the most you still owe is $1k (10% of 10k). With even one child credit the percentage number calculation falls quite quickly (10% of 9k is $900).

If I mess up and under-withhold more than $1000 (in my specific case) - for the next year I will the be required to pay Estimated Tax quarterly

Am I on the right track? I really do hate reading any legal language whatsoever.

[MDM]

...I should plan to shoot for slightly less than the fixed $1000 under-withheld number. And with current tax law, you can do it each and every year without any penalty or other repercussion.

Yes, provided your aim is good enough.

If I mess up and under-withhold more than $1000 (in my specific case) - for the next year I will the be required to pay Estimated Tax quarterly

You never have to pay Estimated Tax.  You just have to pay penalty and interest if your withholding and estimated payments don't put you into any safe harbor for this year's tax return.

Am I on the right track? I really do hate reading any legal language whatsoever.

Yes.  If you read it slowly, it gets easier with practice. ;)