Image courtesy of user Nemo on Pixabay.com

Image courtesy of user Nemo on Pixabay.com

It’s a holiday week, so I’m re-posting popular stories from the past.

This one from 3 years ago explains one of the oddities of Iowa’s “married filing separately” filing status. MFS in Iowa works much differently from MFS on a federal tax return. The deduction for federal estimated tax payments is one example.

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(Originally published May 22, 2013)

Iowa allows a deduction for federal income taxes paid. This includes taxes withheld from your paycheck, as well as any estimated tax payments you made during the year and any additional federal taxes you might have paid when you filed your federal return for the prior year.

This deduction is simple if your only federal tax payments were from paycheck withholdings. You simply report whatever is shown on your W-2 for federal tax withholding. If you’re married and file a separate Iowa return (which most married couples do), each spouse simply reports whatever his or her W-2 shows for federal tax withholding.

It can get a lot more complicated if you’re married, made estimated tax payments, and file your Iowa return as married filing separately.

This is what I’m going to focus on in this post.

Not So Simple

The deduction for federal estimated tax payments is NOT always claimed 100% by the spouse who made the payment. Additionally, joint estimated payments are NOT always split 50/50.

Instead, the deduction is allocated based on the ratio of income not subject to income tax withholding.

Example Setup:

Angie and Alex are a married couple filling separately on a combined Iowa return. Angie’s income consists of $50,000 of W-2 wages. Alex is self-employed and has net income of $40,000. They have a joint savings account that generated $100 of interest income during the year. Alex made $16,000 of estimated tax payments, in his name only and paid 100% out of his sole proprietorship’s separate business account.

Common sense would say Alex would deduct the full $16,000 of estimated tax payments on his Iowa return. But common sense would be wrong!

Example Answer:

The $16,000 estimated tax payment is NOT deducted 100% by Alex. Instead, you must allocate based on income not subject to withholding. In the case of Angie and Alex, they have $40,100 not subject to withholding — Alex’s self-employment income of $40,000, and the $100 of interest income. The interest income is from a joint account and so is split 50/50, so Angie and Alex each claim $50 of it. 

Even though Alex made 100% of the estimated tax payment out of his own separate funds and in his name only, his allocation of the $16,000 payment is $15,980. Angie is allocated $20 of the estimated tax payment.

Here’s the calculation: Alex’s share of income not subject to withholding = $40,000 self-employment income plus $50 interest income. $40,050 / $40,100 = 99.88% x $16,000 = 15,980. Angie’s share of income not subject to withholding = her $50 share of the interest income. $50 / $40,100 = 0.12% x $16,000 = $20.

Obviously the allocation difference of $20 in this example is rather trivial. But let’s look at an example where the difference would be more substantial:

Another Example:

Let’s say Angie is retired and draws income from IRAs, as well as $15,000 of interest and dividends. Taxes are withheld from the IRA withdrawals but not from the interest or dividends. Assume that these investments are titled in her name only. In addition to the IRA withholding, she also makes $5,000 of estimated tax payments during the year. Alex has not yet retired and still makes $40,000 from his sole proprietorship and pays in $16,000 of estimated tax payments.

The total amount of income not subject to withholding is $55,000 — Angie’s $15,000 of dividends and interest and Alex’s $40,000 of self-employment income. Angie’s percentage of the $55,000 is 27.27% ($15,000 / $55,000) and Alex’s share is 72.73% ($40,000 / $55,000). In total, they made $21,000 of estimated tax payments — $5,000 by Angie and $16,000 by Alex. 

Angie deducts $5,727 of the estimated tax payments ($21,000 x 27.27%), while Alex deducts $15,273 ($21,000 x 27.27%).

“This blog post, along with comments that may follow, should not be considered tax advice. Before you make final tax or financial decisions, please secure a professional tax advisor to give you advice about your unique situation. To secure Jason as your accountant, please click on the ‘Services’ link at the top of the page.”