Tax Question

[Mulligan]

Preface this by saying I have been a "Christmas in February" person who over withholds and then receive a nice state income tax refund mostly from a tax credit of staying under 85k AGI. Now that I am starting to get near that threshold I have just lowered substantially my withholdings because this refund (a 1099G) is always applied to the following years federal and thus actually increases my AGI getting me closer to the threshold.
This has got me thinking in reverse when I get to that number. It appears once I hit the crossover amount I could actually over withhold for a few years by increasing my withholdings to stay under the 85k and then counter balance the 1099G add on by increasing even more the state withholdings.
As mentioned the money does get taxed but in the year the 1099G is received and is considered income then in that year. I do not want to do anything illegal, but I have googled to see if over withholding was illegal and the search does not find anything. And if it isn't illegal I would certainly consider it. Has anyone ever adjusted or increased their withholding on income to receive tax credits?


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[RE2Boys]

I don't give out free loans to the govt, just pay enough to stay out of owing a penalty. Would rather owe in April knowing I had use of the money until then. Refunds mean I screwed up.

[Mulligan]

Quote:

Originally Posted by RE2Boys I don't give out free loans to the govt, just pay enough to stay out of owing a penalty. Would rather owe in April knowing I had use of the money until then. Refunds mean I screwed up.

In this situation though RE, it has the opposite effect. If I over withhold my state taxes it lowers my current federal AGI which means I qualify for a $2k tax credit. Then the subsequent year when the over withholding is added on through the 1099G form, you withhold even more to bring income and 1099G add on back under the income limit to capture the tax credit again.


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[RE2Boys]

Oh, your engineering you federal AGI to get a federal tax credit! And using state income tax to accomplish. I thought the $2k was a state credit.
I'm always engineering my federal AGI, but since don't itemize, never thought of using state income tax for that purpose. Plan to do AGI engineering to make sure I can get Education Credits and Exclusion of US savings bond interest when boys are in college.

[Mulligan]

Quote:

Originally Posted by RE2Boys Oh, your engineering you federal AGI to get a federal tax credit! And using state income tax to accomplish. I thought the $2k was a state credit. I'm always engineering my federal AGI, but since don't itemize, never thought of using state income tax for that purpose. Plan to do AGI engineering to make sure I can get Education Credits and Exclusion of US savings bond interest when boys are in college.

Sorry RE, I'm probably explaining wrong but we about there. It is all that above but to receive a state income tax credit. I don't quite no the particulars but over withholding my state does decrease federal income in that year. It does increase it the following year though. But if you keep over withholding more each year it would work in theory until you reached the limit of having them withhold the entire check!


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[kaneohe]

At some point, you might get trapped by AMT because of your high state taxes.
How would your state AGI be defined then?

How does increasing state withholding lower state AGI?
Fed AGI increases as you said because state refunds could be income. Many state AGIs are tied to federal AGI +/- adjustments. But if Fed AGI is increasing, how is state AGI decreasing?

[Mulligan]

Quote:

Originally Posted by kaneohe At some point, you might get trapped by AMT because of your high state taxes. How would your state AGI be defined then? How does increasing state withholding lower state AGI? Fed AGI increases as you said because state refunds could be income. Many state AGIs are tied to federal AGI +/- adjustments. But if Fed AGI is increasing, how is state AGI decreasing?

I have to admit I no nothing about the AMT. I generally owe about 2k in state taxes. So if I over withheld say 3k and then bumped it up 1k each year for a few years to cover up the 1099G increase the following year it would keep me under for a few extra years. But that is a good question as I do not know how much state tax withheld is considered high tax.
To answer your question Kaneohe (the best I can anyways), yes the federal AGI increases each year with the 1099G add on, but if you are at the same time increasing your state withholding it lowers it more than the preceding year because you increased withholding at same time. At some point you would get smashed and have to pay it all, but it would be worth it for the $2k tax credit. I guess in theory, you could also square up one year and forego the credit, then start the excessive withholdings again at a lower amount to get back under 85k.


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[Shawn]

I was thinking of doing something similar in the year before retirement ...

1) withhold much more than needed for state taxes
2) get a large federal deduction due to the withheld state taxes for the tax year corresponding to my final year of employment when my income would be high
3) get a large state refund the following year - my first year of retirement
4) pay federal taxes on the state refund for the tax year corresponding to my first year of retirement, but at a lower rate due to lower income in retirement

I briefly looked into doing this three years ago (i.e., the legalities). I have no idea if this is relevant, but there is a concept known as "recovery." It may be mentioned in Publication 17, although it probably references other publications. I didn't understand it three years ago but my take at the time was that the process probably was not doable. The IRS is going to get the taxes one year or the next.

I gave up investigating this issue since I decided not to retire that year. I still haven't retired and due to an increasing pension it now appears that my marginal tax rate in retirement will be the same as during my working years. So even if it is doable, I don't believe it will be applicable to me. But you might start there (search for recovery in Publication 17). Again, I don't know if the concept is relevant since I never took the time to fully understand it, but it may address the issue.

[Mulligan]

Shawn, some good thoughts you shared. But I wonder since this will not affect the federal taxes but only the state whether this changes things. The left hand and the right hand aren't working together on my issue. The federal is unaware and uncaring about the state issue. But it is the same principal. I am itemizing of Fed which gives the lower federal AGI, which is what the state will go by. The law that I read only mentions the 85k limit each year and does not mention a penalty or clawback into previous tax years. Just either you get it or you don't that year based on the AGI.
I got probably 2 years to figure it out. I came within $750 of losing it accidentally this year due to selling some Intel stock for $5k capital gain and using a one time IRA transfer to an HSA. I couldn't deduct HSA this year and if I had sold the last 200 shares I would have SOL. So it could have been this... $6k capital gains, $1200 paid in taxes and 2k tax credit lost. I would have in effect paid a 53% tax rate on that stock sell.


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[bingybear]

Quote:

Originally Posted by Mulligan In this situation though RE, it has the opposite effect. If I over withhold my state taxes it lowers my current federal AGI which means I qualify for a $2k tax credit. Then the subsequent year when the over withholding is added on through the 1099G form, you withhold even more to bring income and 1099G add on back under the income limit to capture the tax credit again. Sent from my iPad using Tapatalk

I'm not really sure what the goal is here. See bold above. Over withholding does not lower your AGI, full stop. The way one reduces their federal tax with state and local income taxes is by itemized deductions that happen after the AGI is calculated. If you are not itemizing... this likely means no tax savings for you. If you do itemize, then make sure you only include the taxable part of the state tax refund in the following year. If you include some that is not taxable... you just taxed yourself too much.

The process you seem to be talking about really just pushes the taxes down the road... not really giving you a credit unless your taxes drop in future years.

[Shawn]

What you propose could very well work in your situation. As you point out, the federal hand doesn't care what the state hand is doing in your case. What I came across three years ago - or think I came across - was an effort by the federal IRS to prevent people from coming out ahead by over withholding. Much of the tax code seems to target people who try to game the system. It is possible that your state taxing agents have similar rules in place, but it is often so convoluted that it is difficult to understand.

Of course, people can and do take advantage of certain opportunities, such as bundling deductions in a given year so as to itemize instead of taking the standard deduction. Perhaps this is more similar to what you propose to do. In a way, you propose to bundle deductions by over withholding as a means to be on the tax credit side of the $85K threshold.

[Mulligan]

Quote:

Originally Posted by bingybear I'm not really sure what the goal is here. See bold above. Over withholding does not lower your AGI, full stop. The way one reduces their federal tax with state and local income taxes is by itemized deductions that happen after the AGI is calculated. If you are not itemizing... this likely means no tax savings for you. If you do itemize, then make sure you only include the taxable part of the state tax refund in the following year. If you include some that is not taxable... you just taxed yourself too much. The process you seem to be talking about really just pushes the taxes down the road... not really giving you a credit unless your taxes drop in future years.

Actually I am paying more taxes in at the state level to keep my federal AGI down due to the itemizing. I then get it back every year on my state income tax return filing. But what was actually withheld is what is reported on the fed return. Thus in turn generates the 1099G. But while that is going on each year you would just withhold even more. Yes there will come a time when I cannot do it. But every year I can is $2,000 back I would never have been able to receive.


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[Mulligan]

Quote:

Originally Posted by Shawn What you propose could very well work in your situation. As you point out, the federal hand doesn't care what the state hand is doing in your case. What I came across three years ago - or think I came across - was an effort by the federal IRS to prevent people from coming out ahead by over withholding. Much of the tax code seems to target people who try to game the system. It is possible that your state taxing agents have similar rules in place, but it is often so convoluted that it is difficult to understand. Of course, people can and do take advantage of certain opportunities, such as bundling deductions in a given year so as to itemize instead of taking the standard deduction. Perhaps this is more similar to what you propose to do. In a way, you propose to bundle deductions by over withholding as a means to be on the tax credit side of the $85K threshold.

I prefer your explanation Shawn over mine.....It sounds better! I certainly don't want to do anything illegal but if it is not, I will consider the way you described it as the goal!


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[kaneohe]

I agree w/ bingybear.

AGI = wages/interest/dividends/CG/etc. plus taxable part of state tax refund
less adjustments (HSA deduction/IRA deduction/etc.)

If you increase state tax withholding and get some back the next yr, that might
increase your AGI. There is nothing here that reduces AGI when you increase state tax withholding. It does reduce your taxable income and your taxes but not AGI.
http://www.irs.gov/pub/irs-pdf/f1040.pdf

If you think that increasing deductions (state tax) reduces AGI..............

[Mulligan]

Quote:

Originally Posted by kaneohe I agree w/ bingybear. AGI = wages/interest/dividends/CG/etc. plus taxable part of state tax refund less adjustments (HSA deduction/IRA deduction/etc.) If you increase state tax withholding and get some back the next yr, that might increase your AGI. There is nothing here that reduces AGI when you increase state tax withholding. It does reduce your taxable income and your taxes but not AGI. http://www.irs.gov/pub/irs-pdf/f1040.pdf If you think that increasing deductions (state tax) reduces AGI..............

Duh, Kaneohe and Bingybear you are correct. I was thinking I need to work backwards to solve the problem and that will not work. What I will have to do is the opposite and immediately start under withholding this year to receive no state refund so I can avoid future 1099G's. Move a few of my high yielders that I just bought into my tax free Roth account and just hunker down as long as I can to stay under.
If I can make it to 55 I should get one more year with the additional HSA deduction. Thanks for the clarity. I may have screwed up and done the opposite and lost it a year early cause the damage is done by the withholding from the previous year and would be unfixable!


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