Why are You Giving Uncle Sam an Interest-Free Loan?

th[7]Why are you giving Uncle Sam an interest-free loan?  If you’re getting a tax refund at the end of the year, Uncle Sam is using your money interest-free.  If you’re like most Americans, you are an employee (W2) versus a contractor (1099), which means this blog affects you.  Employees file a W4 Withholding Certificate with their employer.  The W4 tells the employer how much of your pay to withhold and send to the IRS.  The lower the number of exemptions the more the employer withholds.  The higher the exemptions, the less the employer withholds.

It is a widely-held belief that a taxpayer can only have the same number of W4 exemptions, or withholding allowances as actual number of dependents.  Some taxpayers also believe the maximum number of exemptions is 10.  Both of these beliefs are myths!! The IRS actually allows a taxpayer up to 99 exemptions as long as the deductions support it.  In fact, as long as you pay 90% of your taxes in advance, the IRS will not assess a penalty.

How do you minimize the tax withholding, pay 90% of your taxes and avoid the penalty – what is the right number of exemptions for you?  If you itemize deductions on your tax return, you can increase your W4 exemptions by 1 for every $3,000 in deductions over the standard deduction ($6,300 for a single taxpayer and $12,600 for a married couple).

Example;

Married couple with 3 kids, and $22,000 in deductions should have 8 W4 exemptions.  Assume this couple currently has 5 exemptions and they are in the 33% tax bracket.  If they change the exemptions from 5 to 8, the employer will decrease the tax withholding by approximately $240 per month x 12 months equals $2,880 per year.

This is a sizable amount of money (not even considering compounding) that you could use to qualify for a larger mortgage for your primary residence, a 2nd home or an investment property.  You could even throw this extra money into your 401K and potentially reduce your taxes.

Take a look at your exemptions and your current income / deductions expected for the year and make the necessary adjustments – make that money work for you and not your favorite Uncle!!

 

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