4

From what I understand, the more allowances I claim on w-4 form will allow me to keep more portion of my paycheck from being taken as taxes. So initially I thought I should always try to claim more allowances when possible.

But my friend told me I am going to pay the money withheld with claiming allowance anyway at the end of the year before I file the tax return. In his theory, I am basically piling up more tax to pay for the end of the year by not deducting them from my paycheck.

Am I paying the same amount of money in the end even if I claim more allowances? If what he says is true, then I would much prefer to pay the taxes I need to pay anyway.

  • 2
    No - you might be paying more if you don;t withhold enough and get hit with underpayment penalties. – D Stanley Dec 11 '17 at 21:14
  • @DStanley Then would it be better to pay more taxes when possible because then I would be receiving more tax refund? – user3000482 Dec 11 '17 at 21:17
  • Basically, the withholding is just a guess on what you're going to owe come April 15. So long as there is no penalty it will have no effect on the final number (withholding + what you pay with your return.) – Loren Pechtel Dec 12 '17 at 2:14
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    @user3000482: No, the best you can do is to estimate exactly what you'll owe in taxes, and pay that. Pay too little, and you have to come up with a big payment when you file the return (plus possible penalties if it's blatant underwithholding). Pay too much, and the IRS is getting the interest on that money until it's refunded to you. – jamesqf Dec 12 '17 at 2:38
  • @user3000482: It's worse for you to receive a refund, because it means you are loaning money to the government for free. It is better for you to owe taxes at tax time (as much as possible without triggering an under-withholding penalty), because that means the government is loaning money to you for free. – user102008 Dec 12 '17 at 3:08
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Neither of you are exactly right (if you've interpreted your friend's theory correctly).

Depending on the number of allowances you claim, a portion of your paycheck will be withheld each period for taxes.

When you file, your total income, exemptions, and deductions will be used to determine how much tax you actually owe for the year. The total amount withheld will be subtracted from that amount, and the net difference will be either what you have to pay when you file (if you didn't withhold enough) or what refund you get (if you withheld more than what you owe).

So it's not technically true that you'd pay back whatever you withheld, but I suspect that's just a bad interpretation of what your friend told you.

Then would it be better to pay more taxes when possible because then I would be receiving more tax refund?

Sure, if you don't mind loaning the Treasury your money interest-free. It's actually not a terrible savings plan for those that don't have strong budgeting discipline. A smarter plan would be to withhold as close to the amount of tax you will owe as possible, so you have neither a large tax bill (which messes up your cash flow and risks underpayment penalties) nor a large refund (which is an interest-free loan to the Treasury).

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If you're going to lend money to the government, buy bonds. They pay interest, unlike pre-paying more tax than you need to. If you have predictable income, and you know what you'll owe at the end of the year, withhold exactly enough that you won't incur any penalties for underpayment.

[New Zealand changed the rules for people like me this year. Whereas previously I paid provisional tax (equal to last year's taxes) twice a year, now I have to withhold at least 10% of all my income. So I withhold exactly 10%. There is no advantage I can see to anyone disciplined enough to be self-employed in the first place to paying more.]

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