Has anyone underpaid taxes as a method of savings?

Question

Maybe I'm not thinking this through right, but it seems that if I dropped my dependents on my W-4 so that my employer takes out the minimum amount of taxes, I could put that money away (I'm a good saver) and earn interest on it. Then I would wait until April 15th to pay the IRS what I owe. What do you think?

Answer 1

What you are thinking/planning is sort of right except that you got the dependants part wrong. You don't drop your dependants (exemptions) on your W-4 so your employer withholds the smallest amount of tax, you actually add more dependants to make that happen. Furthermore, you don't underpay your taxes in order to maximize your gains or savings, you actually pay just enough to avoid underpaying your taxes by more than 1000 and thus not incurr in penalty fees and you also stay away from overpaying so you can use that money for investment. So it is only when you overpay that you actually should be using that extra money you are overpaying the IRS to make some investments/savings.

So, going back to the dependants part. Say you actually have 0 exemptions (dependants) on your W-4, then that means that they would be retaining the highest amount of taxes from your paycheck (in which case you would possibly be overpaying and could make a better use of that money). If you upped that number of dependants to say 3 or 4, then they would retain less tax, (possibly less than what you will actually end up owing them in which case you would incurr in penalty fees which will possibly translate to the same or even more than whatever interest you could have earned by investing that money elsewhere) and thus you would end up with a bigger paycheck.

So, if you are overpaying, stop now, calculate how much you should be paying and have them only retain that amount. Meanwhile take that extra money you were overpaying, invest it somewhere, and watch it grow during that year. That way you gain some interest on the money the IRS would have otherwise kept for you for free and then returned interest free at the end of the year. Note that you will however have to pay tax over that interest earned.

Also note that kind of the same thing applies when you buy a house and you opt in/out of escrow to pay for property taxes on estimated monthly installments. Some people choose to opt out and then at the end of the semester pay all actual property taxes at once. Meanwhile during those 6 months of not paying estimated tax installments each month, they kept that money stowed away somewhere, and they gain some interest over it thus making some profit.

Good thinking! It just requires some discipline and brains...

Hope that helped! Good luck!

Answer 2

ViolentQuaker is fairly close. If you reduce withholding and wind up with too large of a bill on April 15th, the IRS will charge you penalties, wiping out your interest earned (which, by the way, you'll also have to pay taxes on). FYI: self-employed people don't even get away with sitting on their money collecting interest all year. They must make 4 equal payments per year (on 4/15, 6/15, 9/15 and 1/15) and must be paid up by January, not April.

MarineMom is also right that you'll be doing the reverse of what you plan if you reduce your dependent count.

If you don't mind the money being locked away, consider maxing out a 401(k), IRA or other tax-deferred account. You'll reduce your tax bill now and be earning on the money socked away until retirement

Answer 3

I think you will be in jail in no time at all, actually. The more dependents you have, the less the IRS takes out. The fewer means they take more. Single people pay the most. Not having had enough money to cover your taxes taken out of your check is also against the law. I am not sure what the penalty is, or how much, but there are also penalties. Since I have never tried it myself, I'm not sure what the percentage is that the IRS must have, but I know you should have close to what you will owe when you send in your forms. Do let us know if you try it.

Answer 4

If you drop your dependents on your W4 and claim zero dependents, you would actually have more taken out...NOT LESS! The more dependents you claim, the less they take out. There is even a federal exemption that you could check on your W4 where you could have no federal taken out of your paycheck each month, but only if you KNOW that at the end of the year you will not owe any taxes, but get a refund (based on child tax credits and EIC, ect). I would never do that though if I knew that I would owe money in taxes though.

So, if I were you, I would try to rethink your plan and make sure that it would really work the way you think it would! :)

Answer 5

I would stick as close as you can to what you would actually owe. It is what I do. I may get a refund of only $200 or have to pay $100 but I don't think the government should use my money for free all year. At least you are smarter than letting them keep it all year for FREE. Who cares about a big refund- better to SAVE and earn interest all year long:) Kudos to you for that one:)

Answer 6

Why hold on to money that isn't yours? What I would do is claim 0 on your paychecks and add an additional $10 withholding so that you won't have to owe that much at the end.

Answer 7

If you owe over $1000 in taxes above withholding, you have to pay penalty tax. This is to discourage just what you're describing.

Answer 8

I actually do the opposite, I have them take more out. It's not like I miss the difference and it's nice to have that $3500+ refund come every Feb to look forward to.

Answer 9

go to te IRS web site they have a page just for you to calculate just how much you need with held.

Answer 10

you want to withhold just enough so that you don't owe. the IRS is not happy when it does not get its cut during the year.