State and Federal Income Tax Arbitrage
As I noted earlier this week, today is the deadline for second quarter estimated tax payments. Since we’ve experience a relatively sizable uptick in income that’s not subject to withholding, we’re actually on our own for a good bit in the way of taxes. That being said, we can can actually hold back a good bit of this money until taxes are due next spring, allowing us to earn interest on the difference. The key here is to pay enough to avoid an underpayment penalty, but beyond that there’s no need to pay more than you want. Just be sure that you set aside sufficient funds to cover your tax bill when it comes due at the end of the year. In our case, we’re earmarking 50% of net profits to go into a special account to cover our SEP-IRA contributions as well as our state and federal tax liabilities (we make our estimated payments out of that account and will then pay the balance due from it at tax time).
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Filed under: Taxes
About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!
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4 Responses to “State and Federal Income Tax Arbitrage”
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June 15th, 2007 at 3:40 pm
Great! don’t cough oup the money till you have to.
I do the same with federal. I set my exeptions to 25 (so I pay no federal tax) and then max out my 401k. Then, I use IRSs withholding calculator to calc and pay all my taxes in the last month of the year.
June 16th, 2007 at 3:13 pm
Brok – 25 exemptions is aggressive. I use 12 exemptions, and it knocks down my withholding pretty well. I’ve read that 12 is the most you can submit on a W-4 without providing additional information.
I plan on owing $12k – $15k in taxes next April, interest/penalty free.
June 17th, 2007 at 3:08 am
And to think I’ve been paying taxes the hard way all these years.
Is this a great country or what?
July 28th, 2007 at 12:45 am
The converse is also true. If you owe the state money in a calendar year, you can take it as an extra deduction against your federal income, since it was a state income tax paid.