Typically one has a percentage (based on a W-4) of their pay withheld to cover one's taxes at the end of the year, it occurs to me that this is effectively like storing that money in an account with the IRS at 0% interest. Hypothetically would it not be better to calculate your withholding amount and just deposit that into a savings account every paycheck and just use that to pay your taxes. It seems to me that as long as a person is disciplined enough to not touch that account, one could generate some residual income that way. Also as an added bonus if you are in a state that treats a tax return as in income you are now not raising your taxable income. I am thinking there must be a flaw to my logic but I cannot figure out what it is. Is my reasoning valid?

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    IRS would not be OK with you not withholding enough taxes through the year - you will get penalized if you do that. Federal government does want that interest-free loan from you. But you certainly are on the right tracks here realizing that over-withholding taxes is not in your best interest. – void_ptr Jun 24 '19 at 19:46
  • @void_ptr I thought the same thing, but wouldn't sending quarterly tax payments to the IRS like a self-employed individual bypass those penalties? – Nosjack Jun 24 '19 at 19:51
  • The flaw in your logic is that even if you are a very disciplined person who would be sure to place the money in a risk-free account and use it to pay your taxes quarterly, the vast majority of other taxpayers are not that disciplined. And the IRS cares much more about the behavior of a typical taxpayer than about you specifically. – The Photon Jun 24 '19 at 19:56
  • How much would you earn at 2.2%? Would it really be worth the effort? – RonJohn Jun 24 '19 at 20:18
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    "if you are in a state that treats a tax return as in income you are now not raising your taxable income." My state treats a state tax refund (I assume this is what you meant) as income only if you deducted state taxes the prior year. It's a way of accounting for deducting more state tax than was actually due without having to amend your return each year. – D Stanley Jun 24 '19 at 20:28

You've got an interesting theory, but you likely won't be able to actually implement it. Essentially, the IRS wants your tax money during the tax year and not just when you file the return. In fact, the IRS refers to income tax as a "pay as you go" tax. Even self-employed individuals (who have no employer with whom to file a W4) are usually required to submit regular payments (every quarter) during the tax year, or face penalty.

Essentially, your tax return is intended to balance the books, not to be the vehicle through which you determine and pay your entire tax liability.

There are some special cases where employees can be allowed to fill out a W4 in a way that results in no income taxes being withheld. See IRS publication 505 for details. Generally, these exemption requirements will not be met by most wage earning employees - exemption is intended to allow people who will have no tax liability to stop their employer from withholding.

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