Final Year Tax Withholding Strategy

[Senator]

As my final calendar year winds down, I am maximizing my federal and State income tax deductions. I already pay a bunch extra so I do not have to make quarterly payments.

I increased my withholding so I will pay an extra ~$10K to the feds and an extra ~$5K to the State over what I paid last year.

I do not like giving the Government any more than I have to, but pushing income to next year via extra withholding might save a bit in taxes in the long run.

If you are on your last year, it may be something to consider. I see some people wondering of their employer will delay payments to the next year, here is a way to do it yourself.

As far as I know, I do not think there is any limit to the amount you can withhold. If you are getting a $100K bonus, withhold the whole thing if you want.

Of course, if you do OMY after this strategy, it was a failed plan.

 

[kaneohe]

Not sure I understand this............you pay your state 5K extra. IF you are itemizing & are in the 25% bracket (Fed), you might save 1.25K on your Fed taxes this yr. Next yr you have to declare the 5K as income and pay 1.25K extra on your Fed taxes. This is a wash except for what you earn on the 1.25K...........as a tradeoff you lost the use of the 5K.

I understand the 10K to the Feds even less. You gain no tax advantage that I can see.
You pay them 10K extra and they return it next yr so you lost any earnings you might have made for that period.

What am I missing?

 

[sengsational]

I see some people wondering of their employer will delay payments to the next year, here is a way to do it yourself.

Great idea! The post came a couple of years too late for me, but I'd have done it. If I had only known.

 

[RE2Boys]

Don't see the advantage of increasing federal withholding other than making sure you get a refund.

For the state withholding, there may be an advantage on federal return. You could take the deductions while in a higher tax bracket, but have the refund taxed in the following year at a lower tax rate. Also, your total deductions over the two years may be higher if you bunched the deductions in one year and take standard deductions in the next.

Of course, each person's situation is different. I have done the bunching of deductions to my benefit in the past when I have trouble exceeding the standard deduction.

 

[bingybear]

I understand paying the state more in withholding or estimated tax if you itemize. Not sure the recoup if you withhold so much that you pay AMT. If you don't itemize I would think this would just be an interest free loan.

I'm a bit lost on over withholding federal. Federal refunds are not taxable as states can be when itemized. You don't get an itemized deduction for federal taxes as you do for state and local taxes. Could you explain how over funding the federal effectively pushes income into the next year?

I think much of how useful this is depends on when one retires. We retired early this year. Likely not enough income/deductions to make itemizing work this year. At best itemizing may happen every other year if we pay 2 years of property tax in the same year.

 

[pb4uski]

.....I do not like giving the Government any more than I have to, but pushing income to next year via extra withholding might save a bit in taxes in the long run.....

I think you are confused. Increasing federal withholding doesn't affect your reported income one iota.

There is a second order effect on your state income tax withholding so perhaps that is what you are thinking of... but you can accomplish that sleight of hand just as easily by making a state estimated tax payment .... but just remember that your refund is treated as income in the year the refund is received.

If you can get your employer to defer income that is fine too.

 

[Animorph]

No deductions for federal withholding, so I don't see a benefit there.

I knew I was going to Roth convert the year after DW retired. So no big advantage to shifting income/deductions other than a slightly bigger conversion.

 

[marko]

I don't see how increasing your tax payments reduces your income. It does reduce your take home pay but your gross income stays the same even if you gave them ALL your money.

--or am I missing something? Happens to me a lot.

 

[bingybear]

I don't see how increasing your tax payments reduces your income. It does reduce your take home pay but your gross income stays the same even if you gave them ALL your money.
--or am I missing something? Happens to me a lot.

over withholding state taxes can allow someone who itemizes deductions to increase their deduction at tax time. It would not reduce your income, but could reduce your taxable income. Withholding too much could activate AMT for some people.

So, but increasing you deductions you can save some tax. However, the state tax refund will be taxable in the following year. The OP idea was that the following year he would be in a lower bracket... thus he would save some taxes.

does this make sense?

The withholding of extra federal tax dollars... I don't see the savings mechanism.

 

[Senator]

Not sure I understand this............you pay your state 5K extra. IF you are itemizing & are in the 25% bracket (Fed), you might save 1.25K on your Fed taxes this yr. Next yr you have to declare the 5K as income and pay 1.25K extra on your Fed taxes. This is a wash except for what you earn on the 1.25K...........as a tradeoff you lost the use of the 5K.

I understand the 10K to the Feds even less. You gain no tax advantage that I can see.
You pay them 10K extra and they return it next yr so you lost any earnings you might have made for that period.

What am I missing?

I pay extra taxes this year, in hopes I am in a lower tax bracket this year. Taxes are deductible against income, refunds are added to income.

So, if I pay $15K more this year over what I am supposed to pay, I get it back next year as income.

So, instead of paying 28% to the feds on their $10K, and 8%+ to MN on the $5K, I pay next years tax rate(s) on the $15K.

I save a minimum of 3% (28%-25%) if I am on the 25% bracket next year, maybe 13% (28%-15%) if I am in the 15% tax bracket.

No real interest penalty, as savings accounts do not return much anyway.

Unless I am missing something...

The withholding of extra federal tax dollars... I don't see the savings mechanism.

After looking at 2014 tax returns, I guess I do not deduct federal taxes... But I still save state taxes and make sure I do not have to pay in.

 

[jebmke]

I pay extra taxes this year, in hopes I am in a lower tax bracket this year. Taxes are deductible against income, refunds are added to income.

Not federal taxes

 

[marko]

over withholding state taxes can allow someone who itemizes deductions to increase their deduction at tax time. It would not reduce your income, but could reduce your taxable income. Withholding too much could activate AMT for some people.

So, but increasing you deductions you can save some tax. However, the state tax refund will be taxable in the following year. The OP idea was that the following year he would be in a lower bracket... thus he would save some taxes.

does this make sense?

The withholding of extra federal tax dollars... I don't see the savings mechanism.

Makes sense. I hadn't considered the state tax deduction. Sounds like a lot of hoop jumping for a relatively small gain.

 

[Animorph]

One problem with "prepaying" state taxes is that it is a deduction for this year but the refund counts as part of your AGI next year. If you are trying to manage your AGI to avoid ACA limits or other AGI-based taxes this strategy might backfire.

 

[bingybear]

One problem with "prepaying" state taxes is that it is a deduction for this year but the refund counts as part of your AGI next year. If you are trying to manage your AGI to avoid ACA limits or other AGI-based taxes this strategy might backfire.

OP is finishing his final year of full time employment (high tax rate) and expects lower tax rate next year due to lack of working. Topic was saving taxes this way. ACA was not part of the discussion from what I can see.

 

[Senator]

One problem with "prepaying" state taxes is that it is a deduction for this year but the refund counts as part of your AGI next year. If you are trying to manage your AGI to avoid ACA limits or other AGI-based taxes this strategy might backfire.

I am not eligible for ACA credits. I do have free VA healthcare but will likely buy a bronze policy, just in case.

Next year I should have less income, and hopefully? not in the 28% bracket again.

I did get a significant federal and state refund in 2015, so if nothing else, this will help offset the refund (I think...)

 

[scrabbler1]

One problem with "prepaying" state taxes is that it is a deduction for this year but the refund counts as part of your AGI next year. If you are trying to manage your AGI to avoid ACA limits or other AGI-based taxes this strategy might backfire.

I have posted about bunching federal income tax deductions for the purpose of increasing a 2-year total of standard+itemized deductions and lowering my 2-year tax bill. But I also had to net out any tax savings by a reduction in the ACA subsidy in the same 2-year period, thereby making bunching less attractive.