Federal Tax Withholding Rules (IRS Form W-4)
The vast majority of U.S. taxpayers allow the U.S. government to withhold more from their paychecks than is necessary to cover their tax bill due in April the following year. This is largely due to not understanding the tax withholding rules, so the proper number of withholding allowances can be claimed and thus avoid over-withholding.
Each year the IRS has to send some 80 million tax payers refunds totaling $120 billion dollars in excess withholding. This averages some $1,500 per taxpayer. This excess withholding money earns no interest and therefore costs these taxpayers some $6 billion in interest each year!
Many potential Pasadena homebuyers are prevented from buying homes each year because they cannot come up with an extra $100 to $500 per month above their present rental payments. There are also a number of homeowners who would like to move up to more expensive homes, that could use some additional monthly take home pay.
In both of these situations, it may be important to know the tax withholding rules, as these individuals may be able to increase the number of withholding allowances they claim on their W-4 tax withholding certificate. (See sample W-4 that follows.).
Contrary to popular belief the number of withholding allowances any individual may claim at their place of work is not their family size (nor 14 as many people believe). They are allowed to claim up to a maximum of 99 withholding allowances, as long as they have the tax deductions to back up the claim.
An individual on W-4 withholding can claim an allowance for himself, one for each dependent and one more for each $3,000 of tax deductions, over the standard tax deduction barrier. These tax deductions may include interest payments on mortgages for first and second homes, real estate taxes, moving expenses (if itemizing), charitable contributions (if itemizing), alimony, medical bills (above the deductible amount), some individual retirement accounts, some child care expenses and some stock or business losses.
READ MORE: Federal Tax Breaks to Owning Real Estate
If you need additional monthly income to be able to purchase a home, I recommend that you arrange an appointment with an accountant or CPA who can advise you of the proper number of withholding allowances to claim.
However, the following general rules may be helpful in illustrating that you may claim extra withholding allowances for the purchase of a home. This, in turn, would give you more monthly take home pay in order to be able to budget the home.
GENERAL WITHHOLDING RULES:
• One additional withholding allowance may be claimed for every $3,000 of itemized tax deductions, once the taxpayer has enough tax write-offs to itemize. This amount is in addition to withholding allowances for family size. ($5,450 is the minimum amount of deductions for a single taxpayer to itemize and $10,900 is the minimum amount for married couples to itemize).
• Individuals may claim as many tax withholding allowances as they desire, up to a maximum of 99, as long as their actual tax deductions support the claim. IRS tax rules state that you must pay 90% of your tax bill in advance each year, or you may incur tax penalties in the form of interest charges on the unpaid advance taxes.
• Each additional withholding allowance claimed by the individual on the W-4 withholding certificate, will result in less money being withheld from that individual's paycheck by the employer. The actual amount of additional take home pay will depend on the individual's tax bracket. If the tax bracket were 28%, each additional withholding allowance claimed would shelter $3,000 of income. Therefore, 28% x $3,000 = a tax savings of $840 per year or $70 per month, for each extra allowance claimed. Three such additional allowances would generate close to $210 per month in extra take home pay!
• The employer does not have the right to tell the employee how many tax withholding allowances to claim. This is up to the individual. However, many large companies provide someone to help the individual estimate how many tax allowances to claim.
• The purchase of a home usually entitles an individual to claim extra withholding allowances on his W-4 and therefore, receive more monthly take home pay. The exception would be when the home purchase and the resulting deductions are not large enough to itemize.
Information courtesy of Jeff Elias.