I am not a lawyer, a CPA, nor an enrolled agent, and this is
not tax or legal advice.

I think most of the answers have assumed you are itemizing
in both years and that your tax bracket is the same in both
years. With those assumptions, most of the advice seems
sound to me. There are some other scenarios to consider.

To simplify this, I'm just going to call setting dependents
to zero for state tax purposes "the strategy". This assumes
that setting dependents to zero results in your receiving a
refund of state taxes for year 1 in year 2.

If you don't itemize in year 2, but itemized in year 1, the
refund will be taxable income in year 2. So the strategy is
a loser in that case.

If you itemize both years, but are in a higher tax bracket
in year 2 due to a raise, larger bonus, or other event, the
strategy works to your disadvantage. You are moving income
into the higher-tax year.

If you itemize both years, but are in a lower tax bracket in
the second year, the money will be income, but taxed at a
lower rate, so there is some benefit. How much depends on
the difference in your tax bracket.

If you live in a state where you may take a sales tax
deduction or a state income tax deduction, and you use the
sales tax deduction in year 1, the strategy is probably to
your disadvantage. OTOH, if you underpay state taxes by
setting dependents to 9 and have to pay with your year 1
return, you've potentially saved a little by moving that
deductible expense into year 2. This last scenario has the
risk of underpayment penalties (I think you'd be limited to
something like ten percent of the total), so you really,
really, really should see someone who understands the tax
laws in your state before even thinking about it. Which
would be a good idea anyway.

The other thing to bear in mind is that the tax savings may
not be enough to pay for the CPA's time to evaluate them,
depending on your income.

But controlling your dependents is one of the few ways
general wage earners can affect the year in which they
receive income, and you will often see lots of advice
suggesting that you move income into one year or another.
This advice usually appears too late for this strategy to do
much about it, though.

Hank Murphy
speaking only for myself

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- quote -

Yes, deduct what is shown on your W-2 as well as any other
state tax payments that you made throughout the year
(usually quarterly state estimated tax payments and the
prior year's balance due). Keep in mind, though, that if
you overpay your state taxes and get a refund, that refund
amount must be reported as income if you deducted the taxes
in the prior year.

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When you itemize one year, and you get a refund on your
state income tax, you report the refund on line 10 of the
form 1040 the next year. This makes the amount that you
deduct correct and jive with what you actually paid the
state. If you have to pay extra you add the amount to the
next years tax return. If you have city or county tax
withheld don't forget to add all of it together and itemize
it on Schedule A.

Missy Doyle

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"beckkl" <kylebeck[at]gmail.com> wrote:

- quote -

If you have a state or local refund in the year you itemize,
it has to be added back into your Federal return on the
front of the Form 1040 (Line 10) the following year. By
artificially increasing your withholding, you'll just
increase the amount that has to be added back in the
following year.

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"beckkl" <kylebeck[at]gmail.com> wrote

- quote -

Yes, for the most part. Add to that for any state taxes
paid when you filed your return (was it a balance due?). Of
course, if any estimated state tax payments were made,
account for those also.

- quote -

Any refund is added to your income (if you itemized in the
prior year).

- quote -

And state tax refunds are added to your federal income if
you itemized your deductions.

--
Paul Thomas, CPA
paulthomascpapc[at]bellsouth.net

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- quote -

Yes, that's correct.

- quote -

When you get the refund of the overpayment, it is taxable
income that you have to report on your federal return for
the year in which you receive it (on Form 1040 line 10). So
the more you deduct one year, the more taxable income you
have the next year. In effect, you end up with a net
deduction roughly equal to your actual state tax liability.

For example, say your state tax on your W-2 for 2004 was
$4000. In 2005 you file your tax returns for 2004, and
deduct the $4000 on Schedule A of your federal return. On
your state return your actual tax liability is $3000, so you
get a refund of $1000 from the state, which you receive in
2005. Now let's say your state tax on your W-2 for 2005 is
again $4000. In 2006, when you file your federal return for
2005, you will again have a $4000 deduction on Schedule A,
but you will also have $1000 of additional income - the
state tax refund. The deduction reduces your taxable income
by $4000, but the refund increases your taxable income by
$1000. So your net deduction is $3000, which was your actual
state tax liability for 2004.

There are some complications that can come into play, but
the basic concept is as I have described. In case you are
wondering, at the end of the year the state will report your
refund on a Form 1099-G, with a copy to you and a copy to
the IRS.

Bob Sandler

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beckkl <kylebeck[at]gmail.com> wrote:

- quote -

When you pay the extra, or get a refund of the overpayment,
that affects your federal income tax for the year of the
payment.

- quote -

And then you'd owe taxes on that refund.

Seth

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"beckkl" <kylebeck[at]gmail.com> wrote:

- quote -

Don't forget that state tax refunds are taxable income for
federal purposes (assuming you're not using the standard
deduction). This is because you got a deduction for state
taxes on Sch A in the prior year. That's why it doesn't
make sense to claim zero or otherwise significantly over-pay
just to get a bigger fed deduction.

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"beckkl" <kylebeck[at]gmail.com> wrote:

- quote -

You are doing it correctly. On the Federal Schedule A you
list the amount you actually paid for state income taxes in
the tax year.

If you pay more state tax than required during any one year,
you can deduct the total paid for THAT tax year. But the
refund you receive the following year counts as income in
the year received, so you don't gain anything, and can lose,
depending upon circumstances. Also, as far as I know both
the IRS and state tax departments frown on this.

--
Vic Roberts
Replace xxx with vdr in e-mail address.

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"beckkl" <kylebeck[at]gmail.com> wrote:

- quote -

Yes

<snip
- quote -

When it becomes taxable income on your Federal return.
That's the part you missed.

--
Phil Marti
Clarksburg, MD

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I am a bit confused as to the way I should be calculating
the state tax dedection on the Schedule A. Last year I put
in the amount of state taxes I paid as shown on my W2. Is
this correct? It doesn't seem right to me that I can deduct
the amount I paid throughout the year, as this doesn't
necessarily reflect what my state income tax liability will
actually be. According to my interpretation of the Schedule
A's instructions, I did do it correctly. If that is the
case, why would anybody claim something other than 0 on
their state W4? If they did, they would lose the ability to
deduct some extra money from their federal taxes. You would
end up getting any overpayment back from the state at the
end of the year anyway.

Kyle

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