Allowances/Withholdings in regard to taxes

[KingNothing]

Hello all, and forgive my amateur financial knowledge. I suppose that mathematically, the best way to do your taxes is to have as little withheld from your paycheck as possible, and to pay it all in at the end. This way you can potentially make (typically low-risk) investments with the money in the meantime.

However, I do not understand how the allowances/withholdings work. Every website I go to just gives information about how to calculate these based on dependents and spouses and such. They don't say the actual mathematical effect.

So, what is the effect of these numbers mathematically? Also, what are the limits, if any, on the numbers that one can put here?

 

[russ_watters]

http://www.irs.gov/pub/irs-pdf/fw4.pdf

 

[Moonbear]

Be careful about having too little withheld too. You can end up paying additional penalties if you aren't having enough withheld and aren't paying estimated taxes quarterly.

 

[KingNothing]

Be careful about having too little withheld too. You can end up paying additional penalties if you aren't having enough withheld and aren't paying estimated taxes quarterly.

Aw, shucks. So if I rent the basement of a house, am I "head of household"?

 

[jtbell]

Be careful about having too little withheld too. You can end up paying additional penalties if you aren't having enough withheld and aren't paying estimated taxes quarterly.

Specifically, if the amount you pay during the year (via withholding or via estimated tax payments directly to the IRS) turns out to be less than 90% of the tax that you actually owe at the end of the year, you may be subject to penalty.

I say "may" because the rules are a bit complicated. As I recall, a major exception is that if your income goes up significantly from the previous year, you're not subject to penalty if your withholding etc. is at least as large as your actual tax for the previous year. This gives you a year to make adjustments in your withholding, or estimated tax payments. This affected us one year when we started getting a lot of interest and dividend income which wasn't figured into our salary withholding. We didn't have to pay a penalty that time. Rather than mess with estimated tax payments, we raised our salary withholding above the default amount for the following years.

 

[Containment]

I remember someone telling me you can put about any number you want in there you don't really have to justify it I'm not totally sure that's correct but the guy was an accountant at one point. Anyhow the guy also told me that if you make it so you get all the money up front it makes it far more likely that you will get an audit so if you don't keep good records or want the hassle your probably better off not putting something like a 9 or 10 down. I personally wouldn't mess with it because I know my chances of blowing "extra" money is higher then me properly investing it.