Going tax exempt on paychecks means that an individual chooses not to have any federal income tax withheld from their wages or salary by their employer. This decision can have both advantages and disadvantages, and it is important to consider various factors before making the choice to go tax exempt.
When someone elects to go tax exempt, their employer will not withhold any federal income tax from their paycheck. The employee must meet certain criteria to be eligible for this exemption, including expecting to have no tax liability for the current year and having had a refund of the entire amount of federal income tax withheld in the previous year. While this exemption is only applicable to federal income tax, it is also possible to request exemption from state income tax withholding, depending on the state.
One of the main reasons individuals choose to go tax exempt is to increase their take-home pay. By not having any federal income tax withheld, their paychecks can be significantly higher. This extra cash can be used to cover various expenses or put into savings. However, it is crucial to remember that this increase in take-home pay does not mean a person is not responsible for paying taxes. It simply means the responsibility of paying taxes is shifted to the time of filing their annual tax return.
To determine if going tax exempt is a suitable option, one must consider their personal financial situation, including any potential eligible deductions and credits, such as mortgage interest, child tax credit, or education-related benefits. It is also essential to assess the potential consequences of going tax exempt. For example, if someone ends up owing a large amount of tax at the end of the year and is unable to pay it off in full, they may face penalties and interest charges. Therefore, it is crucial to evaluate one’s ability to handle a potential tax bill.
Another factor to consider is the potential impact on other financial aspects, such as retirement savings and Social Security benefits. By not having taxes withheld, individuals may have to plan and save accordingly to ensure they meet their retirement goals and receive the maximum benefit from Social Security when the time comes. Failure to do so could result in financial difficulties later in life.
It is also important to mention that the choice to go tax exempt is not permanent and can be changed throughout the year. If an individual realizes that they need to start having taxes withheld or face penalties, they can adjust their withholding status accordingly. However, it is crucial to stay updated with the tax regulations and deadlines to ensure compliance and avoid any issues with the Internal Revenue Service (IRS).
It is worth noting that going tax exempt is not applicable to everyone. For individuals with significant tax liabilities, it is generally not advisable to choose this option. Additionally, employees who receive large bonuses or other irregular income may not be eligible for tax exemption since special withholding rules apply in these cases.
It is necessary to consult with a tax professional or use appropriate tax calculators to estimate the potential tax liability and determine if going tax exempt is a suitable option. These professionals can provide personalized advice based on an individual’s specific circumstances and goals. Furthermore, it is always a good idea to review and update tax withholding status annually to ensure it aligns with any changes in financial situation or tax laws.
In conclusion, going tax exempt on paychecks can have pros and cons, depending on an individual’s financial situation and goals. It can provide a temporary increase in take-home pay, allowing for more flexibility in managing one’s finances. However, it is important to remember that taxes still need to be paid and should be budgeted for accordingly. Consideration of potential tax liabilities, retirement savings, and other financial factors should be taken into account before making the decision to go tax exempt. Seeking advice from a tax professional is highly recommended to ensure compliance with tax regulations and to avoid any penalties or interest charges.
Do you pay rent or have a mortgage?
What your co-workers are doing is just stopping paying rent/mortgage.
Then they’ll end up finding out they owe the entire year’s worth of rent/mortgage in one big lump.
And they may get charged penalty/interest for doing this.
And they may get forced to stop doing this.
But the basic concept is that you still owe rent/mortgage regardless of whether you pay it every month (every paycheck) or all at once in one big lump (on your tax return).
Depends on how much you make and what other sources of income you have and if you are married, etc.
But, in general, what your coworkers are doing is just putting off paying their taxes now to pay them later. That means when it comes time to file in early 2024, they will have a big bill. It may also come with penalties for underwithholding for the year. Bad situation for most folks, if they are trying to game the system to get a little bit bigger paycheck each time and then don’t save the money for later.
Yeah that’s pretty dumb, they’ll be totally screwed come 2024 tax season. If they truly won’t be liable for taxes (which is rare), and they know what they’re doing, then maybe it’ll work.
One scenario where you could be where married couple filing jointly makes a very disproportionate amount of money and the higher paying job pays the vast majority of taxes. The lower paying could go “Exempt” because it all gets tallied at the end. This assumes (I am not a tax expert) that the IRS does not penalize them for doing exempt. I would be surprised since the couple file jointly and all money and withholdings are aggregated.
> how exactly does it work?
They stop having their taxes withheld from their paychecks
> Do they eventually have to pay back the taxes?
Of course they do. They’ll owe one big lump sum in April. Plus penalties for not withholding enough from their paychecks.
> Good idea or bad?
Awful idea.
I do this occasionally (once a year) along with some of the guys I work with. We go tax exempt on checks that we work a lot of over time on.
If we have to work like 14 days in a row the over time really adds up and you get more taxes taken out of your check. So we go tax exempt and receive a large chunk of cash. If you do it once or twice it won’t hurt but you’ll get less back at the end of the year.
Just don’t do it for a long time and don’t forget to change it back.
The amount of taxes taken out of your paycheck is just an estimate. How many exemptions you claim at work doesn’t change how much taxes you do or don’t owe at the end of the year, it only changes how much is taken out of each paycheck. If they aren’t having enough taxes taken out, then they are going to owe a big lump sum once they do their annual tax filing.
>Personally I don’t think it’s smart but how exactly does it work?
They have no income taxes withheld on their paycheck, their take home increases.
>Do they eventually have to pay back the taxes?
withholding ≠taxes; they have the same tax liability regardless of their W4 settings. Futzing with your W4 just affects whether you owe the IRS or the IRS owes you in April.
>Good idea or bad?
Bad idea. If you’re on track to get a refund then it’s better to just update your W4 to be accurate *all* the time. If you under withhold too much, you will have penalties on top of the regular taxes owed.
Are your coworkers college kids working 20 hours a week?
A lot of your co-workers are most likely in for a BIG surprise come tax time.
You need to be aware of the difference between tax “withholding” (what comes out of your paycheck) and your tax “liability” (what you actually owe the IRS for the income you earn).
Going exempt only changes your withholding. It tells your employer’s payroll system to keep back $0 for federal tax (and state if you do the same on their form) regardless of what’s actually on your paycheck as far as taxable income. So the amount on your paychecks getting deposited into your bank account is bigger because part of it isn’t getting sent to the IRS.
But then at the end of the year you gather up all your financial documents and do your tax return. That’s where you calculate your liability from your income (and deductions and credits and whatever). That “total tax” number is completely independent from what you had withheld.
The next step of the return is to compare your tax owed against tax paid. If paid > owed then you get a refund of the difference since it wasn’t actually necessary to cover your bill. If paid = owed (pretty rare to hit this exactly) then you get nothing for a refund and owe nothing more. If paid < owed, then you have to send in a final payment to settle up.
The IRS expects workers to pay taxes “as they earn”. But there is some wiggle room. If that final payment ends up being <$1000 then they consider it a wash and no further action is needed. But if that final payment is >$1000 (and no other waiver exists) then you still owe that money **plus** an extra penalty for underpaying during the year.
Now, there are valid ways for someone to have $0 withheld without claiming exempt. If they have extra deductions / credits they get to claim on their return and those get included on their W-4, then the withholding calculation could end up estimating they’ll have a $0 liability for the year so hold nothing back from the paycheck. This is a much more appropriate path to take than using “exempt”, even if it ends up with the same result.
Whether you have taxes withheld from each paycheck or not, your tax obligation in April is going to be what it’s going to be. All this is doing is delaying the inevitable. Hope for their sake, your wise guy friends are putting away some of their earnings now for their monster tax bill in the spring.
When they say they are going exempt…are you sure they are talking about taxes? In the US, an exempt employee is something totally different. Exempt are paid salary no matter what vs hourly, but lose our on overtime pay.
PURELY ANECDOTAL: I’ll just say that when I was younger, I worked factory work for a couple of years. Once a year, for about 4-6 weeks, I’d go tax exempt. Then, I go back to my normal withholding. Never ended up owing at the end of the year. It helped massively when I was there, as I was living paycheck to paycheck.
Bad idea unless they have enough assets so that a tax bill of several thousand dollars is easily paid from savings. But I suspect that any who thinks this is a good economic plan has no assets and will be gobsmacked when they find out what they owe in April.
There is such a basic level of not understanding simple economics like how marginal tax rates work OR what the difference is between FICA taxes – employer share and income taxes.
People should determine how much they should have deducted in order to either not receive a large refund or not owe a large amount depending on their preferences.
In some circumstances one might deliberately claim a huge number of taxes. For example, if one starts a job at the end of the year after being unemployed or underemployed during a large part of the year, one is going to be taxed AS IF one’s marginal rate is for the annual salary because that is the payroll default. So you go to HR and do something specific for your circumstances that year. And then you readjust the next year when your economic situation is different.
Be glad you never have to deal with the supreme idiocy of a co-worker who is convinced he doesn’t own any taxes because they are unconstitutional. This was said at a lunch with several lawyers who just pointed out that the Sixteenth Amendment to the US Constitution was passed in 1913 and specifically dealt with the constitutionality and legality of the Federal Income Tax Law.
I have seen this a number of times. Individuals in prior tax years who received large tax refunds, elect to change their statis to ‘exempt’ today to get their money now (rather than later in a tax refund). Also common in the bankrupt community as the trustee receives the tax refund (instead of the individual).
Very common.
I’ve consistently done this BUT with the advice and input from my CPA. Yes, you eventually must pay back, however, after 10 years of getting a tax refund, Ive adjusted my withholdings and/or lowered my withholdings because I cannot pass up on HYSA interest rates. I was getting a tax refund of $10K. You must be diligent and NOT spend it though!
A young kid at work was explaining this to me yesterday.
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His last job had guys who would regularly go on 10+hours of overtime a week. They would go exempt for no more than 2 paychecks and somehow convinced themselves that they were making out like bandits on this. The trick they explained was to not do this more than two pay checks per year or else you would owe.
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I tried to explain to him that uncle Sam WILL get his bread no matter what tricks you think you are pulling.
OP all I gotta say is that a lot of your coworkers are just dumb and probably don’t have good financial sense. Please stay out of what they are doing and let them find out for themselves. Will find out next March if what they did was a very smart move and in for a big surprise tax bill.
100% they will be shocked and forgot why they have such a large tax bill. Human nature is not good at remembering these small details once they get used to something.
As someone who works in the industry, I’m constantly amazed at people’s terrible financial decisions especially in a group.
It’s a dumb move. They should go do the IRS estimator so they correctly fill their W4. They will get bigger checks throughout the year and a $200-$400 tax refund. No more giving uncle sam an interest free loan. https://www.irs.gov/individuals/tax-withholding-estimator
Per the IRS instructions for W4:
*If an employee qualifies, he or she can also use Form W-4 to tell you not to deduct any federal income tax from his or her wages. To qualify for this exempt status, the employee must have had no tax liability for the previous year and must expect to have no tax liability for the current year.*
This does not exempt you from FICA.
A different strategy is to claim a large number of deductions. Example: I have 99 kids. This can allow you to temporarily avoid taxes. You set a larger number at the beginning of the year, and then the correct value near the end. The payroll system will sense you are behind and will “true up” to the needed amount. This will result in those last paychecks take-home amount being smaller.
It IS possible to be truly exempt from owing income tax to the IRS, like if you’re a single parent, head of household, with lots of dependents and very little income (my very first year being divorced and claiming my kid, I was broke enough that I got more back in credits than I owed–the IRS paid ME to be a taxpayer that year!), or if you’re a teenager with a part-time job who made less than a certain threshold (a few thousand a year, I think).
Otherwise, nothing in life is certain except death and taxes, so you will need to pay taxes some way or another.
You CAN mark your W-4 with any level of withholding you want. You can put that you’re exempt, that you have 17 kids, or that you have zero even though you actually do have 17 kids. That is not a binding truth-telling document. It’s merely to get your withholdings to the level they need to be, and especially in married couples, they may just have one person do all the withholding for the marriage and the other person put “exempt.” The government doesn’t care up until tax time.
At the end of the year, you plug all your information into a 1040 (or variation thereof). Your income, any exemptions, standard or itemized deductions, any tax credits, and the **payments you’ve made to date** (either quarterly estimated payments for 1099 / self-employed workers, or withholding from paychecks for W-2 employees). If it all comes out to the IRS owing YOU (zero to infinity dollars, doesn’t matter) or you owing the IRS BELOW a certain amount, you’re good to go. One of you pays the other, and everything is hunky dory, and it truly doesn’t matter what you put on that W-4 at the beginning of the year (or beginning of your employment).
If, however, YOU owe the IRS, and it breaks their threshold where they feel like you were purposefully underpaying and they were taking on risk that you wouldn’t pay, NOW you have to pay penalties, interest, and they’ll be making sure you DO pay throughout the year going forward, and may be more susceptible to audits.
So again, they don’t care the actual situation vs. the W-4, but if they feel like they got screwed or could have potentially gotten screwed, they’ll make your life miserable.
The basic idea with going exempt is that federal taxes aren’t taken out of your paychecks so you take home a little more. However being exempt doesn’t mean you don’t owe the government that money. When you do your taxes for this year is when you ’settle up’ with Uncle Sam. If you prefer to get a refund it’s probably best not to go exempt. I will do it for a few weeks a couple times of year when I need some extra funds but I do the math to make sure I don’t stick myself with a big tax bill the following filing season.
When I was young and stupid, I would ask my boss to claim exempt on some of my checks. Come tax time, I was on the hook for something like $800. It was quite a sum of money for a kid making $15,000 a year.
Long story short, don’t do it unless you are actually exempt.
I did that one year when I wasn’t making a lot and bam, I got smacked with a huge tax bill plus penalties. Never. Again.
If you will owe taxes, claiming exempt when you’re not isn’t legal. So there’s that.
It’s a good idea if you are smart and understand tax law and are patient and willing to sit down and do your taxes yourself.
You’ll end up paying around the same but you’ll keep all your money instead of overpaying and waiting for a tax return.
It really depends on your situation.
Yes you always have to pay your taxes or go
To jail (and probably still have to pay your taxes). If you want to go crazy you can go exempt and use that money to invest. However I think if you owe too much taxes they will make you do estimated quarterly
I did that at my first job. Because I made less than the legal requirement to file so it made sense.
If you don’t have to file then why let them take your dollars? But if you gotta file I would recommend you do it like normal