Roozbeh wrote:Filling form W-4 (and its state equivalent DE 4), both seem to talk about allowances one is "entitled" to.
Here is what W-4 says:
Whether you are entitled to claim a certain number of allowances or exemption from withholding is
subject to review by the IRS. Your employer may be required to send a copy of this form to the IRS.
Here is what IRS Pub. 505 says:
You can claim only the number of allowances to which you are entitled.
Also from Publication 505 (page 7):
You do not have to use the Form W-4 worksheets if you use a more accurate method of determining withholding allowances.
The method you use must be based on withholding schedules, the tax rate schedules, and the 2012 Estimated Tax Worksheet in Chapter 2. It must take into account only the items of income, adjustments to income, deductions, and tax credits that are taken into account on Form W-4.
Publication 919 gives more extensive worksheets, but even they do not cover all of the necessary situations. If your calculations show that you can expect to cover all your taxes with a given number of allowances, you should be allowed to claim them.
Here is what California DE 4 says:
Under the penalties of perjury, I certify that the number of withholding allowances claimed on this certificate does not exceed the number to which I am entitled [...]
When I fill the details of form DE 4, I get to 2 state allowances. If I use that for the rest of the year, I would get a $2000 state tax refund, and that's if we don't contribute to charity at all.
There is a worksheet on DE-4 which allows you to adjust for deductions; if you expect to contribute $5000 to charity, then you should claim five more exemptions, so your tax due should break even.
CA normally follows federal tax law except when it explicitly chooses to disagree. I don't know whether the rule allowing you to ignore the form is valid in CA, so you should check with your tax advisor. (However, when CA increased withholding rates but not tax rates, the Franchise Tax Board commissioner said that taxpayers could adjust their withholding accordingly.)
When I compute our California tax liability for 2012 and figure out the minimum number of allowances that would get me to no state tax refund, I get to 26 state allowances! If I claim 25, we would still get a refund! The main reason is that the worksheet in the DE 4 form does not include our tax situation.
One reason for the huge number is that a CA allowance is $1000, while a federal allowance is $3800. If you are paying $19,000 in mortgage interest, that is 19 extra CA allowances but 5 extra federal allowances.