Big deduction for state tax: implications on estimated tax payments, AMT, penalties

Since it already happened, let's not worry about simplicity. What did you actually pay?

-Mark Bole

No, because of AMT. If you expect your net income this year to be

100K, then likely you're not in AMT and your taxable income will be $0. You have to run the numbers through a computer program.

There is a thread "Estimated Tax Issue (Hypothetical)" going on right now in this newsgroup. You can read it for additional info if you want.

When you fill out Schedule AI of form 2210, you will be asked to compute your tax for each quarter, and to do this you use the usual method -- which includes AMT, foreign tax credit, etc. Say for the first quarter (January to March 31) you had 40k AGI of which 5k was qualified dividends, and the foreign tax credit was $200, and CA state tax paid was 4k. Annualize the numbers by multiplying by 4; this gives you 160k AGI, of which 20k qualified dividends, $800 foreign tax credit, 16k CA state tax. Calculate the tax on this annualized amount using regular form 1040. Then divided it by 4 to get the first quarter installment, but as you only have to pay 90% of the tax due, multiply this quarter tax by 90%; or in other words multiply the annualized tax by 22.5%.

I suggest you download a form 2210 tax calculator instead of trying to do this manually. Your $100,000 state tax deduction will make a huge difference, and could push you into AMT territory. The calculator will compute all this.

ed

Mark, I was trying to anonymize a bit here, but I see your point that the actual amount may matter.

Answer: 270k

Hi Ed, I suppose this would be the spreadsheet from edco software. Boy, I wish there was something simpler I could do. That spreadsheet is nearly as complex as full tax software, if you ask me. Great effort, though on the spreadsheet,.

Ok, some more numbers:

270k state tax for 2007 paid in 2008, and to deduct against 2008 income. Not expecting any substantial regular income in 2008, just cap gains as shown below.

q1: 75k cap gains, paid 20k(fed)+8k(state) est tax q2: 85k cap gains, cintemplating paying 25k(fed) and 8k(state) est tax q3: maybe similar q4: maybe similar

Should I just pay it and get it over with? Is there any big downside? I don't expect to get much more than 2% on this cash anyway, so maybe I should just pay as if I didn't have the big deduction and get it over with. What interest rate will IRS pay me on overpayment :-)?

If that's all there is to it, it will be easy with any regular tax program. For Q1, just multiply 75*400 for annualized AGI. Calculate the state tax quarterly payment first, probably something like 22.5%*10%*300kg50 in California and pay it. Of course, there are deductions, AMT, mortgage interest, etc to consider. Then calculate the federal Q1 installment; use the state Q1 paid times four (to annualize the itemized deduction) as well as the 270k paid for last year.

As your income is pretty high, you could just pay a pro 1k to 2k to take care of it as well as some financial planning. For example, if you don't take any capital gains in Q2, Q3, Q4 then you probably will get the full benefit of the 270k deduction as you likely won't be in AMT (and you'll even get the stimulus credit for your 2008 federal return). On the other hand, your income might be so low that part of the 270k will be forever lost. And besides, you might need some money.

If you overpay your Q1 installment or any installment, you don't get any interest. Muni mutual funds may give a better return than the 2% of banks, though there is some risk if the bond price falls.

Removeps,

"Estimated Tax Issue (Hypothetical)"

Thanks, I have read it. I found Ed's general hints particularly useful. They also seemed to coincide with common sense, which makes life easier when trying to remember complex rules.

As an aside, I always suspect that many laws in general and tax rules in particular would be much easier to understand and remember if one only knew the real *intent* behind the rule, and how the rule implements that intent.

Unfortunately, laws and tax rules do not come with manuals that explains what the authors were thinking when they wrote the rule.

For example, AMT continues to befuddle me. I do not understand which aspect of AMT rules prevented some ~500 richest families of ~1970 from not paying taxes.

I would love to see a very simple and concrete example of an abuse that AMT (originally) shut down. Please don't tell me AMT is all crock, I'm sure it is (or was) good for something :-).

With tax rules, there is so much algorithmic and procedural blah-blah about subtracting and adding weird categories of numbers that the intent and big picture is completely lost, at least to me and I think to most people.

Well, that was a bit of a rant, but if anyone has a simple AMT-kills-this-abuse example I'd love to see it. Especially something that involves the deduction of state taxes :-).

Removeps,

Thanks for the great tips with my guesstimated numbers. I hadn't thought about the fact that the 270k deduction only reduces the fed TI (taxable income) and not the state TI.

I guess that means that I should probably pay fed=0 for the rest of the year, modulo the assumptions that you spelled out..

I also did not realize that any unused portion of the 270k deduction does not roll over to next year. I suppose I should try and "use it up" if I can. I'll try not to fall into the trap of minimizing tax at the expense of maximizing profit :-). I winder what would happen if I managed to producer just about 270k in gains, would AMT do any harm?

About tax pros: You are probably right., I should use one. Is it common that a tax pro will provide you with a copy of their software and the electronic data and pdf files that was generated? I like the idea but I very much want to own my data afterwards.

The following assums no other income, $75,000 long term capital gain in the first quarter and $85,000 in the second quarter, a total of $270,000 state tax paid in the first quarter and too much tax to uses the "Last years tax safe harbor" Filein married file jointly with only

2 exemptions (athough as you'llsee this doesn't make any difference).

The $270,000 State Tax as an itemized deduction actully wipes out all your regular tax leaving you with only AMT without the benefit of the $270,000 deduction, or ROUGHLY as follows

First Quarter LTCG $75,000 annualized * 4 = $300,000, minus only $7,500 of AMT Exemption leaving taxable AMT of $292,500 of which $66,100 is taxed at 0% and the remainder of $226,400 taxed at 15% for amt tax of $33,960 * .225 =$7,641 for the first quarter installment. You paid $20,000 so no penalty. The second quarter works out to $13,187 tax for a total cumulative due of $21,458. So you only owe $1,458 for a second installment.

ed

More and more software packages make it fairly simple to provide clients with a .pdf of the tax return. Some even provide for some excel files to be eiher uploaded or downloaded. Factoring this into the cost of the return is an interesting exercise.

But the software itself belongs to the vendor and generally cannot be distributed by the tax preparer. And there are often internal comments and internal workproducts that, if they were deemed property of a client, would certainly affect the procedures followed by tax preparers.

Ed, wow!. Turns out that the 75k+85k gains are STCG. Could I just reduce the 15% with 28% and get the numbers I need? Interesting to see that AMT does indeed kick in.

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It's not linier. As short term CG your first installment is $17,640 and second is $29,169 for total of $46,809, so you owe $26,809 now.

ed

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Yeah. That spreadsheet is almost as "complex" as an IRS 1040, Schedule D, Schedule A, form 2210 AI and 6251 combined. For someone sharp enough to earn over $25K per month trading this market it should be a piece of cake. After plugging in the presumption that you're married without children ,under under age 65, and 75,000 into the first quarter of Schedule D and $160,000 into the second quarter, and $270,000 into both quarters of line 6 of Schedule A, and that you already paid a $20,000 installment, the bottom line of form 2210 reads out your remainder due and the detail of the forms it calculated for you are all available. To recalculate from my initial stab at it I just moved the $75K and $160K from line 10 of Schedule D to line 3. The 6251 and 2210 Sched A calculate automatically.

Now, if you want "compliex" try Publication 505 and its Worksheets manually and they don't even do the AMT. I wish I could steer you to a simple "estimator" but there aren't any that will do this by quarters annualized.

You said "I also did not realize that any unused portion of the 270k deduction does not roll over to next year. I suppose I should try and "use it "." Forget it. you totally lose the deductuion for State Tax with the AMT.

ed

Ed, how can 46809/160000=0.293 be the effective tax rate under AMT rules, given that max AMT rate is 28% as far as I know?

There are phaseouts, so the maximum marginal AMT is more like 35% (possibly higher).

Seth

Seth, Wikipedia agrees with you that the AMT exemption phaseout above 150,000 causes the marginal rate to increase towards 35%, but my observation was about the effective (aka. average) rate. How can the effective rate be over 28% of gross. I simply do not understand how that is mathematically possible.

,

Derk: The annualized income for the 2nd quarter, cumulatively, is $384,000 (160K*2.4). the TMT on 384K is $104,020 ( by then you've lost the entire AMT Exemption so it's .28 * 384,000-35004,020)) Multiply that by .45 factor to get cumulative tax due for 2nd quarter $46,809.. They get you on the factors, 2.4 X .45 = 1.08. Probably because of the short (2 month long) quarter. Another reason not to make quick estimates when annualizing.

ed

Note that if your AGI is larger than a threshold (around 150k), then your itemized deductions are phased out. The phase out is small -- about 3k for every 100k above the threshold -- but be aware that it's there. In addition, the Bush tax cut is phasing out the phaseout, so in 2008 and 2009 the phaseout will actually be only 1k if I'm not mistaken, and in 2007 it was 2k.

They're required by law to give you a copy of your return (in addition to the one they file by paper if you choose or have to file by paper). It's good to dig into the details yourself so that you know what's going on. Many tax preparers won't dig into details. For example, they may not tell you to make state estimated payments in the year your income is high in order to get the benefit of those deductions, or they won't dig into deductions for medical expenses with clients over 70 years old, etc.