Gaming The Tax Code: My $145k Interest Free Loan.
For an audio version of this post, please click on the speaker icon (top left).
The Tax Code created by the Internal Revenue Department contains lines and lines of mind-numbing rules that only serve to obfuscate its readers.
I am not sure about you, but my eyes start to glaze over anytime I am forced to read even a few stanzas of tax code verbiage.
I am one of these people that tend to quickly click accept on any legalese I encounter online (such as the Apple ITunes user agreement).
But there are some hidden gems buried deep in the tax code that can actually prove to be quite beneficial and let you game the tax code system to your benefit.
I will share how I gamed the tax code system and essentially received a 13 month interest free loan from good ole Uncle Sam for over $145k.
The Game’s Afoot.
2019 was a remarkable year for me.
Courtesy of cashing in on my grand slam investment, I brought in more money than I ever had in any point of my life.
The proceeds from the sale of my medical building, coupled with my regular work income as a radiologist, plus the money generated from the perpetual Passive Income machine I created, allowed me to recognize an adjusted gross income that was 10x greater than my pre-tax salary as a first full year attending.
However with mo money comes mo problems.
Specifically 2019 was also going to cause me to have the largest income tax hit ever.
At my organization, the Chief Financial Officer was kind enough to prepare for each investor the estimated tax hit each of us would be subjected to from the sale of the medical building.
Based on this analysis, I was given a ballpark number of $273k of capital gains taxes, etc owed from the proceeds of the sale.
I was able to lower this tax burden right off the bat by choosing to leave $100k of the proceeds back in the building as a “reinvestment” that was offered by the purchasing entity, bringing my tax burden down to around $250k.
The Quarter Million Dollar Dilemma.
The sale of the medical building was in early May of 2019 and I received a check shortly after.
I knew that $250k of that money was really not mine but Uncle Sam’s, whom I am positive couldn’t wait to get his hands on it.
I could just send the entire amount owed to the IRS right away and be done with it.
But was it in MY best interest to get the money to Uncle Sam right away?
For those who have read my post, “I Lied About Being Debt Free And Why I Am Happy About It,” you will know that I prefer to never receive a tax refund but instead am happier when I owe the IRS on tax day.
Instead of giving the government an interest free loan (which a tax refund amounts to), I much rather have the opposite play out with the government giving me an interest free loan instead.
I wanted to hold onto this money as long as possible.
But I was no longer dealing with a 4 figure amount that I would owe.
Nope this would definitely be in the 6 figure range, my largest score to date.
Now the IRS/Uncle Sam is no fool.
They much rather have access to taxes owed sooner than later (whereas I was trying to channel my inner Wimpy and gladly pay them Tuesday for a hamburger today).
For those who are not W-2 employed and have funds automatically withheld, you are already familiar with the Quarterly Tax Payment system which serves to spread your income tax evenly throughout the course of the year.
These quarterly payments are typically due on 15th of April, June, September of the current tax year, and January of the following year.
Because of my asymmetric large bolus of income, if I chose this route to settle my debt with the IRS, I would have to divide it amongst 3 payments as I already missed the first quarter date.
Instead of the first option of just cutting a check to the IRS right away to pay off this additional tax burden, this method would allow me to potentially make money with the additional time I had with the designated payoff fund.
However after each deadline for the quarterly tax payment, my “borrowed capital” would be cut by 1/3, with the first one just 30 days from when I received the proceeds.
Not a bad option, but I was greedy and still wanted more.
The key was holding onto this money without getting hit by penalties from the IRS for delayed payment of taxes owed.
Using the rules of the tax code game to my advantage.
Was there a way to hold on to the funds earmarked for tax payment to the very last minute?
Fortunately I did not have to wade through reams and reams of tax code to find the answer.
I happened to stumble on an article that helped unlock some tax rules that could be exploited by me.
The IRS has created safe harbors which, if you follow the strict guidelines, allow you to circumvent any underpayment or delayed payment penalties for taxes owed.
My safe harbor of choice was the one that involved using last year’s tax liability.
It is vital to understand that the IRS does throw in a little kink into the above safe harbor as it applies to high income earners (the second highlighted paragraph).
In essence to qualify for this safe harbor as a high income earner, take the total amount of what you owed in income taxes for the PRIOR year and multiply that by 110%.
As long as you have that amount withheld prior to Dec 31st you will not be hit with any penalties no matter how large an amount you end up owing the IRS when you do file.
With the game plan set it was time to enact it.
So what steps do you need to take to make sure you have withheld 110% of your previous year’s tax liability?
If you are a W2 worker you have two options:
- You can reduce/eliminate the number of deductions used to withhold money from your paycheck.
- You can submit a W-4 form to increase the amount you want withheld.
Option 1 was definitely a no go for me because I already have the number of deductions set to 0 for withhold on my paychecks.
Also there was no way I could use this method to get me to the level of withhold I would need.
So option 2 it was.
The W-4 form was actually quite simple to enact for my particular situation.
Based on the total amount I paid in 2018 taxes and multiplying it by 110% I came up with the desired number.
I also had to calculate how many paydays were left in the year after I submitted my W-4 form and then calculate how much withhold was necessary from each paycheck to hit the minimum 110% target.
That amount was then put in Step 4c of the form and voila I was done.
Game. Set. Match.
At the end of the year I not only met the 110% minimum withhold needed to avoid the ire of the IRS, I exceeded it by about $60k.
[The reason for this variance was that I did not account for the extra paychecks I received when I requested pay downs on money I accumulated over my base pay.]
After all the accounting was done, the amount I owed the government was $145.7k.
Because of the kink the COVID-19 pandemic threw into the tax season, instead of having to pay the owed balance in April, I got an additional 3 months of interest free loan from the IRS.
I waited until the last day (July 15), went to the post office with my return and saw the all-important postmark stamped on the envelope.
I knew there was no way the check would be cashed that day and had a transfer from my savings account to my checking account scheduled for the next day, milking it for as much interest as I could.
[The $145k+ check ended up being cashed on July 24th.]
Back in May 2019 when the proceeds check first cleared, the interest rate for my online savings account (Discover) was 2.2%.
Over the months it slowly bled down to the current interest rate of 1.01%.
This makes it very difficult to find out exactly how much interest I received for this “free government loan.”
I did a ballpark estimate and decided to make the blended interest rate for this time frame 1.75% (the dramatic drops in interest were more recent occurrences).
There were 426 days between the time I deposited the check and the time I transferred it to my checking account for the IRS payment.
Based on the above assumption, I earned $2976 in interest (almost $7/day) by exploiting this tax code.
No, this was not an earth-shattering amount of money but given the amount of effort it took to get it (less than 30 minutes), I was well compensated for my troubles.
Points to consider.
Obviously the interest rate will play a major factor in gains if you decide to follow suit.
Lower interest rate environments like what we are currently experiencing would require a larger amount in play to make it something to write home about.
It is also vital that you put the money owed to the IRS in something that is safe (savings account, money market, or CD).
The last thing you want is a sudden drop in value right before the deadline and not have the necessary funds to pay the IRS.
The ensuing penalties incurred would wipe out any gains made from this time arbitrage game.
If you are in search of financial help, please consider enlisting the service of any of the sponsors of this blog who I feel are part of the “good guys and gals of finance.”
Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
NOTE: The website XRAYVSN contains affiliate links and thus receives compensation whenever a purchase through these links is made (at no further cost to you). As an Amazon Associate I earn from qualifying purchases. Although these proceeds help keep this site going they do not have any bearing on the reviews of any products I endorse which are from my own honest experiences. Thank you- XRAYVSN