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I withheld too much in taxes this year. I will benefit a good amount from the Lifetime Learning Credit, which I hadn't heard about until today. Even if I don't pay a cent in taxes for the rest of the year I will still get a refund come next year. As such, I want to make my remaining 2017 paychecks as beefy as possible, but I also don't want to face an IRS penalty.

My concern stems from this passage in IRS Publication 505:

Penalties

You may have to pay a penalty of $500 if both of the following apply.

  • You make statements or claim withholding allowances on your Form W-4 that reduce the amount of tax withheld.
  • You have no reasonable basis for those statements or allowances at the time you prepare your Form W-4.
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You may have to pay a penalty of $500 if both of the following apply.

What the IRS really cares about is you not withholding enough, so that you send them a big check (EDIT: during tax season).

https://www.irs.gov/taxtopics/tc300/tc306

The United States income tax system is a pay-as-you-go tax system

If you didn't pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax.

Thus, tweaking things now to not get a huge refund is ok.

Just remember to update your W-4 in January!!!

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IRS Publication 505 discusses the penalty for filling out form W-4 incorrectly:

Penalties

You may have to pay a penalty of $500 if both of the following apply.

  • You make statements or claim withholding allowances on your Form W-4 that reduce the amount of tax withheld.

  • You have no reasonable basis for those statements or allowances at the time you prepare your Form W-4.

There is also a criminal penalty for willfully supplying false or fraudulent information on your Form W-4 or for willfully failing to supply information that would increase the amount withheld. The penalty upon conviction can be either a fine of up to $1,000 or imprisonment for up to 1 year, or both.

These penalties will apply if you deliberately and knowingly falsify your Form W-4 in an attempt to reduce or eliminate the proper withholding of taxes. A simple error or an honest mistake will not result in one of these penalties. For example, a person who has tried to figure the number of withholding allowances correctly, but claims seven when the proper number is six, will not be charged a Form W-4 penalty. However, see chapter 4 for information on the penalty for underpaying your tax.

Of course, the question then becomes: What is considered a "reasonable basis" for the number of allowances that you claim? The text goes on to say that the penalty will only be assessed if you "deliberately and knowingly falsify your Form W-4 in an attempt to reduce or eliminate the proper withholding of taxes." In my very limited experience, the IRS doesn't care how many allowances you claim as long as the amount of tax you are having withheld is ultimately correct. In my situation, I claim many more allowances than the worksheets tell me I should. Because of my deductions, I end up with a refund every year regardless, meaning that I am still having more tax withheld than I owe, despite the high number of allowances claimed.

However, if you do claim a high number of allowances on your W-4, and then end up with a high tax bill on your tax return, that is another story. Be careful.

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You are not allowed to just claim as many allowances as you want. You might get away with it, as I did for many years, but that doesn't make it legal. You are likely to get away with it because employers don't routinely send W-4's to the IRS; they only do so when the IRS requests it. If the IRS does discover it, they may impose a penalty, even if you had the correct amount withheld to avoid an underwithholding penalty.

However, as far as I know, you are allowed to base the number of allowances you do claim on credits that will lower your taxes due. So in future years you can file a W-4 which will minimize your refund or amount due.

I am not clear if you are allowed to file a high-allowances W-4 to make up for overwithholding in the first part of the year. I would use the IRS W-4 calculator. As with all IRS tax advice, it's not binding on their part, but at least you can guess from how they implemented it, if the programmers thought it was legal to correct an early-overwithholding situation like yours with a bunch of allowances.

Source: careful reading of publication 505.

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