An increasing number of traveling clinicians are claiming "exempt" on their W-4s when they should not. Others are simply claiming one too many exceptions. In this, the final installment of our three-part series addressing the "Employee's Withholding Allowance Certificate," we look at the consequences of making an error on your W-4.

Tax due

The purpose of the W-4 is to set or adjust how much federal income tax is withheld from your paycheck. With either of the scenarios above, the first effect of a W-4 error will be to increase your tax liability—either reducing your refund or putting you in the "tax due" category at tax time. For most travelers (who are in the 25 percent federal tax bracket), each numeric exemption error will result in an additional $850 federal tax liability for 2007—plus state taxes.

In addition to more taxes due, under-withholding can result in multiple penalties. If you file your return and pay your tax due by the tax deadline, you will still be subject to an under-payment penalty of 7 percent if you owe more than $1,000 for failing to "pay-as-you-go" during the year. If you don't file and pay on time, you will also be subject to an additional 5 percent per month late-filing penalty (up to a maximum of 25 percent) on the tax due; plus a late-payment penalty of 1/2 of 1 percent per month, up to 25 percent of the unpaid amount due; plus interest on the tax and penalties.

Hardly worth it

Gross offenses, like claiming "exempt" with a large income, can also result in unwanted attention by the Internal Revenue Service (IRS). The agency can issue a "lock-in" letter to your employers to set a minimum withholding threshold. With the promise of extra taxes, penalties, interest, and IRS attention, the short-term benefits of "exemption from withholding" hardly seem worth the long-term consequences.

The preceding discussion is general in nature, and should not be considered advice for any individual tax situation. You should consult with your personal tax planning professional for specific guidance relating to your unique circumstances.