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On 1/4/11 1:36 PM, someone wrote:
 | I seem to remember a string sometime previously about the relative merits of changing paycheck allocations prior to receiving a bonus.
Assuming the general idea is to get the most out of a bonus – give less to the gov’t (in the short term of course) and keeping more for immediate use and not saving for the eventual rainy day (like a 401k) -- then one can change their tax withholding dependents from a few (pay more taxes) to more (pay less taxes). And similarly, since bonuses come early in the year when the 401Ks are virtually empty, it might make sense to change that allocation for the pay period, in order to not pull your full % allocation from the bonus. In theory this makes sense to me if I want more of the bonus in my pocket in the short term. Has anyone done this? If so, why and would you do it again? |
Almost a for sure way to owe taxes at the end of the year
Without any changes to withholding, a higher percentage of bonus checks is withheld than your normal paycheck, simply because all of your standard deductions that you can claim are “used up” against your regular income. This causes taxes to be withheld on only a portion of your paycheck, but against all of a bonus check, since the bonus check is over and above your regular rate of pay. So it makes the tax rate on the bonus seem higher.
If your bonus check had an identical percentage of tax withheld as your paycheck, it would almost guarantee you would owe taxes at the end of the year, assuming you weren’t overwithholding and normally receiving a tax refund at the end of the year. I’ve had this problem at previous companies when I got a bonus that was withheld like a regular paycheck, and then was surprised with owing a lot at the end of the year because of those bonuses.
As far as changing 401K allocation, carefully consider if you can make the money work better for you in your hands, than putting it in the hands of the 401K administrator. I doubt many wealthy people got that way because of 401K contributions, they probably took more risk and found ways for their money to work for them with a better rate of return.
Consider the legality of your W-4 filing
According to http://definitions.uslegal.com/w/withholding-allowance/
 | An employee can claim the number of withholding allowances that they are entitled to based on the Form W-4, Employee's Withholding Allowance Certificate, worksheets. An employee can claim less than you are entitled, but not more. An employee may not arbitrarily pick a number with the goal of avoiding income tax withholding. The law provides for a civil penalty of $500 for filing a false statement on Form W-4. |
http://www.irs.gov/pub/irs-pdf/p15.pdf mentions “An employee who submits a false Form W-4 may be subject to a $50 penalty.”
This page has some alternative opinions on why people claim extra allowances: http://www.nwtrcc.org/practical1.php It mentions reasons the IRS and Employer can reject a W-4, and also gives more details on issues with W-4 forms.
On a related note, Trying to keep track of all taxes of every kind paid for a year