Absent a definitive IRS ruling on what constitutes the proper withholding of taxes, we're all merely speculating. One might guess that nobody thinks the IRS will seek penalties, issue lock-in letters, etc., if someone owes $1 at filing time. Nor for owing $2, or $3, or...? So, what might "the proper withholding of taxes" mean in practice?I believe the IRS procedure is not to collect a penalty, but to issue a "lock-in" letter, ordering the employer to withhold based on X allowances (old style) or $X deductions (new style) instead of what is reported on the W-4. This can force the taxpayer to overwithhold for years.Have there been any cases of the IRS coming after anyone who meets a safe harbor, has no history of tax problems, and pays that year's total tax due in a timely manner?You are not supposed to claim salary withholding that only suffices to meet the safe harbor. When you file the W-4, you certify that you are entitled to the withholding that you claim, and the IRS defines this as enough to cover the tax you expect to owe.
If so, it would be interesting to know the story.
If not, perhaps this is akin to the wash sale rule: the IRS hasn't defined "substantially identical" but based on IRS actions one can infer an operative definition.
In both cases, as in many others, you certify your own compliance with the tax laws. When you file Form W-4, you certify that you are entitled to the claimed withholding. When you file Form 8949 or Schedule D to report capital losses, you certify that you are entitled to claim those losses.
As with the wash sale, the IRS may not enforce the rules because it does not have the records. You can reduce your withholding because you have just made a large donation to charity, taken out a mortgage, or become eligible for a tax credit, and you can be underwithheld because you receive a large year-end dividend or capital gain. The IRS cannot distinguish these situations from deliberate underwithholding. Similarly, the IRS cannot easily know about a wash sale except for the case that the brokerage is required to report. It is clearly a wash sale to sell a fund and buy the same fund in your IRA, but the IRS doesn't track purchases in IRAs.
Reading between the lines under Checking Your Withholding, we see (emphasis added) "You should try to have your withholding match your actual tax liability." In other words, that's a good idea but doesn't rise to the level of "must try...".
A little further down, Pub. 505 has
In other words, meeting a safe harbor implies no need to "check your withholding."You should check your withholding when any of the following situations occur.
...
You prepare your 2023 tax return and get a:
... Balance due that is:
... Subject to a penalty.
In years of increasing income, it is reasonably common for people not to change their W-4 and rely on the "100%/110% of last year's tax" safe harbor to avoid any penalties or lock-in letters from the IRS.
The hypothesis then is that in practice "proper withholding of taxes" means "having avoided underpayment penalties". As with any good hypothesis, this is falsifiable: do we know of any case in which the IRS has levied penalties or issued a lock-in letter to someone who meets a safe harbor, has no history of tax problems, and pays that year's total tax due in a timely manner?
Statistics: Posted by FiveK — Sun Oct 06, 2024 11:07 pm