posted on March 8th 2017 in LA/OC CFP Team Posts with 0 Comments /

If you haven’t read my last two posts about filling out withholding forms and justifying low withholding, please take a look! Next up, I’d like to share some insider tips to make tax withholding work for you, especially if you started off with the wrong withholding rate, or if your income or deductions change during the year.

What If I Am Way Ahead On My Withholding?

In one case, my client withheld far too much in the first half of the year, due to excessive salary withholding and a large bonus. I suggested he claim a number of allowances high enough to completely stop his withholding for the rest of the year. The number claimed was higher than the worksheet on the form would normally allow, because he had claimed far too few allowances at the beginning. When the IRS asked, we provided a projection of the client’s expected total income and deductions for the year, and showed the withholding was already above the expected tax liability for the year. The IRS accepted this without further comment.

Again, you should always check with your professional tax advisor about anything out of the ordinary you propose to do with your W4.

What If I Am Way Behind On My Withholding?

To have more withheld from your pay, just file a new W4 with a smaller number of allowances.  It’s very complicated to predict how much each allowance will affect your withholding. For this reason, I usually recommend making a modest reduction in allowances (say 10% to 20% of the number you’re currently claiming), seeing the effect on the next paycheck, and adjusting further from there. You don’t want to cut allowances too fast, and find you have little to no take-home pay! But if there are only a couple paychecks left in the year, you may not have this luxury, so make your best guess.

Also, if you expect to receive a bonus later this year (paid in a separate check, not just added to a salary paycheck), remember that this will be withheld at flat rates of 25% federal and 10.3% California (for 2017).  Since this is higher than many people’s actual tax rates, bonuses often produce extra withholding, which can help you catch up if you’re behind.  Of course, you won’t know for sure until you receive the bonus!

What If I Failed To Make Estimated Payments?

Here’s one of my favorite tricks.  I ‘m going to show you how to use your withholding forms like a time machine, to increase the amounts you are deemed to have paid to the IRS in prior months.

If you realize a very large capital gain mid-year, or have an increase in self-employment income, an estimated payment could be required within a month or two. This is why it’s important to keep your financial and tax advisors in the loop all year.

If you fail to make estimated payments on time, you may be hit with a significant penalty for underpayment of estimated tax. This is true even if you try to catch up by making a big estimated payment in the fourth quarter. That’s because the IRS knows when you submit estimated payments, and they want them evenly throughout the year (or, in this example, whenever extra income arises).

Here’s how withholding can come to the rescue. The IRS only learns about your withholding when they receive your W2 from your employer each January, showing your total numbers for the prior year.  Because they don’t know when the withholding actually happened, they assume it happened evenly throughout the year.

So if you are behind on your estimated payments, you can divert a large part of your remaining paychecks to withholding for the rest of the year. Withholding from your paychecks, regardless of when it actually happened, can be treated as having arrived evenly each month of the year, so it is effectively pushed back in time to prior periods. This may be enough to eliminate any problem of underpayment.

In extreme cases of underpayment, you can even divert your entire net paycheck to withholding! To do this, claim zero withholding exemptions, and also fill in a large dollar amount on line 6 of the W4 as “Additional amount, if any, you want withheld from each paycheck.” You should probably check with your HR department to confirm that, if this amount would consume more than your net pay, they’ll at least take what they can, taking your net pay to zero.

This is a huge headache for your payroll people, and may be impossible depending on the software system in use, so it should definitely only be attempted as a last resort. Also, be absolutely certain check with your tax advisor before doing this. Your advisor may have other, less drastic measures that can be taken. And of course you should check your bank account, and check with your spouse, before diverting your entire paycheck to the IRS!

Also, you should definitely coordinate with your tax preparer.  They may need to file an extra form to avoid the penalties, and if you’re relying on the “time machine” method I have described, the form can be time-consuming to prepare (because you have to help them basically break every single item of income into how much arrived during each quarter of the year).  If the penalty for underpayment will be less than the cost of preparing the form, it may not be worthwhile.  It might not make sense if the penalty will only be $100 or so.  But I’ve seen this “time machine” method work miracles when a new client comes to me mid-year, while there is still time to fix things.  

There is one more important step to remember, if you are diverting most of your paycheck to withholding.  Before the year ends, file a new W4 in time to take effect for the first pay period of the following year. If you don’t, you’ll have no take-home pay in January, either! Any Form W4 you file stays in effect until you file a new one, even from year-to-year.

In Summary

In this series of articles, we’ve discussed “quick and dirty” W4 filing, and fine-tuning for other income and adjustments.  We’ve talked about the California forms, and I have offered to help you with the math, at no cost or obligation.  (Just call or email me.) And I have shared some powerful insider tips for special cases, including how to go back in time to fix problems created earlier in the year.

Your WorthPointe financial advisor can make sure you and your tax advisor are on the same page regarding your income, deductions, cash flow, and withholding. Working together, we can make sure you don’t have huge tax bills or huge tax refunds in April next year.

If you would like to brainstorm with us about any financial issues you are facing, please contact us to start a conversation!

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