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Back in 2014 and 2015 I had W-4 on file with my employer where I claimed only one exemption (myself).

However, I always ended up owing federal tax and getting CA state refund. Last year I also ended up incurring capital loss, but still the same situation - CA state tax is overpaid, but federal tax is underpaid.

Also, today I found out from one of my coworkers that he has the same issue and this year he ended up paying penalty for underestimating his federal taxes.

Is this a bug in ADP? Are they supposed to withhold the right amount of taxes, if my only income is from my Employer? Would they swallow underestimated tax penalty, if I filed W4 correctly, but they withheld less?

P.S.

  1. I am single and don't have any dependents.
  2. No one else can claim me as dependent.
  3. Besides base salary I also receive employer stock (ESPP, RSU, NSO). However, employer withholds taxes for these stock transactions through my broker (I see them broken down on my W2). Also, I do "same day sale" so there is no capital gain.
  4. I have been subject to Alternative Minimum Tax.
  5. This year I have also instructed my employer to withhold extra federal income tax and also updated my W4 to have 0 exemptions.

Update: I am not blaming ADP for anything right now because I don't have to pay penalty.

  • 1
    Owing tax or getting a refund is not evidence that the withholding is not done properly. Is that your only evidence? It's on you to request withholding that matches your tax situation or to make estimated payments for the difference. – user32479 Apr 13 '16 at 21:20
  • @Brick I am reading this book "Stand Up to the IRS" and it seems that if ADP goofs up Payrool taxes then ADP will cover penalties for Employer [books.google.com/…. Wouldn't this be also considered goof-up if they are not withholding tax according to my tax profile in W-4? I think that my employer forwards all W-4s to them? – john1234 Apr 13 '16 at 21:33
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    Are you referring to the taxes you owe as a "tax penalty" or is there actually a penalty? A payroll vendor does not know your whole income and deductible expense situation. All a payroll vendor can do is project out your earnings to an assumed annual amount then withhold based on the communicated exemptions. This is a very rudimentary calculation that generally works pretty well. With that said, if you only receive W2 earnings from a single employer, you really shouldn't be in a situation where you're subjected to an underpayment penalty.... – quid Apr 13 '16 at 22:20
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    Wait. You have been subject to AMT? That would imply that the withholding could never match your situation. – mhoran_psprep Apr 13 '16 at 22:42
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    W-4 is just for federal. Exemptions for state should be calculated based on state forms, which for California is DE 4. – user102008 Apr 13 '16 at 23:35
7

ADP does not know your full tax situation and while the standard exemption system (actually designed by the IRS not ADP) works fairly well for most people it is an approximation. This system is designed so most people will end up with a small refund while some people will end up owing small amounts. So, while it is possible that ADP has messed up the calculations it is unlikely this is the cause. The most likely cause is that approximation ends ups making you pay less tax during the year than you actually owe.

A few people like your friend may end up owing large amounts due to various circumstances. It is always your responsibility to make sure you pay enough tax throughout the year. While this technically means that you need to do your taxes every quarter during the year to make sure you pay the correct tax during the year, for most people this ends up being unnecessary as the approximation works fine. It is possible the exemption system failed your friend, but much more commonly people owe penalties because they put the wrong number of exemptions or had other side income.

On a related note, most people in finance would argue that your situation where you owe some money at tax time, but not so much that you have to pay a penalty, is actually the best way to go. Getting a tax refund actually means you paid more tax than you needed to. This is similar to giving an interest-free loan to the government.

2

I see several interesting statement in your question.

A. my only income is from my Employer

B. I also receive employer stock (ESPP, RSU, NSO). However, employer withholds taxes for these stock transactions through my broker (I see them broken down on my W2).

C. I have been subject to Alternative Minimum Tax.

A implies a simple tax return. B and C tell the opposite story. In fact if B is not done correctly The amount withheld due to payroll may be perfect but the under withholding could be due to the ESPP's, RSUs and NSOs.

The AMT can throw everything else out the window.

If a person has a very simple tax situation: Income doesn't change a lot from paycheck to paycheck; they take the standard deduction; the number of exemptions equals the number of people in the family. Then the withholding is very close to perfect.

The role of the exemptions on the W-4 is to compensate for situations that go above the standard deduction. The role of extra withholding is when the situation requires more withholding due to situations that will bring in extra income or if the AMT is involved.

  • Regarding B ... On my W-2 for RSUs, NSOs and ESPP I see the taxes that were withhold by my employer through broker; also transaction history in E*trade confirms this as well (for each sale there is TAX transaction that withdraws money). Also, in my case I do same-day-sale, so there is no extra gain after RSU or ESPP vesting (in fact due to transaction fees this incurs most of the time negative capital gain). Same thing for NSOs. So I would say ADP and my Employer know how B should be taxed. – john1234 Apr 14 '16 at 18:00
  • Regarding C ... Why my Employer and ADP could not anticipate that I could be subject to AMT? Since they know all my income then they could anticipate this, right? Perhaps I am oversimplifying how AMT is calculated? – john1234 Apr 14 '16 at 18:04
  • People who are subject to the AMT generally have high deductions. You have never explained your deductions. – mhoran_psprep Apr 14 '16 at 18:21
  • @HalfWay You can see yourself in the below calculator how the AMT is calculated by the IRS. It's not really ADP or your Employer's job to calculate this, but as you can see I doubt they have most of this information on you. irs.gov/Individuals/… – rhaskett Apr 14 '16 at 23:17
0

Surprised no one has suggested this, but for one with State Refund and AMT situation, it could be that last year state refund (i.e. what you overpaid in State Taxes last year) may end up fully (and incorrectly, because you did not receive any benefit that year) recognized as income this year. Refer to this IRC:

(a) Deductions Gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter.

Or this article that explains Tax Benefit Rule under "Taxpayer pays the alternative minimum tax in year 1." paragraph.

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