California taxpayers: How to benefit from your state IOU now

Consumer Reports News: July 13, 2009 12:23 PM

The basket case government of California, which has been unable to raise taxes and unwilling to cut spending, has come up with a bill-paying scheme that your fiscally irresponsible big brother probably used on you after filching money from your piggy bank when you were kids: I.O.U.'s

On July 2, the California State Controller began issuing I.O.U.'s for state obligations—including tax refunds. Most of California's 12.8 million taxpayers are a trusting lot. This year, 65 percent of them let Sacramento withhold more in state income taxes than was necessary. The result: More than $6.6 billion in taxpayers' money piled up in the state's coffers. Of course, the state spent this money, rather than hold it for safekeeping. The average refund due is a not-unsubstantial $789.

The I.O.U.'s, known as "registered warrants" in financial circles, are supposed to be redeemable on October 2, "assuming there is adequate cash in the Treasury," says Controller John Chiang. The California Bankers Association said in a press release, "We have learned that if sufficient cash is not available by the October 2, 2009 maturity date, registered warrants may be issued to cover those previously issued registered warrants."

California taxpayers, shouldn't sit still for this. We advise you to turn your California I.O.U. into cash right now. Here are four ways to do it:

Join a credit union. As of today, 55 California credit unions have announced their intention to accept the I.O.U.'s, according to the California Credit Union League. That provides a great excuse to join a credit union, where interest rates on loans and savings are typically better than those offered by banks.

Big California banks only accepted the I.O.U.'s from July 2 through July 10, but the state bankers association advises consumers to "talk to their bank, even if their bank has made the decision not to accept these warrants. Many banks are prepared to assist their customers in other ways to get through this fiscal crisis."

This is the simplest way to get your money. You get the face value of the I.O.U., but not the 3.75 percent annual interest, which goes to the financial institution that takes it. However the interest is only worth $7.40 on the average refund check if you pray until October 2. Better to get your $789 cash today and pray for other things at your chosen place of worship, we think.

Use the I.O.U. to pay state sales tax on a major purchase. If you're about to buy a car or other big-ticket item that will also come with a big state sales tax bill, you can use the funny money to pay the tax.

Use the I.O.U. to pay other bills to the state. The Department of Motor Vehicles, for example, will accept the I.O.U. toward payment of your vehicle registration or other fees and taxes.

Temporarily reduce your current paycheck withholding. While California isn't paying you what it owes, it has no shame in continuing to take from you through your salary withholding. But you can turn the tables on Sacramento.

It's perfectly legal for you to temporarily increase your number of state exemptions on file with your employer to reduce this year's withholding by the amount of the I.O.U., says, David Shaw, president of the California Society of Enrolled Agents. (Members of his organization are tax professionals who prepare tax returns and have the top Federal tax credential for representing taxpayers before the Internal Revenue Service.)

But Shaw strongly urges cautions about a risk: After you get what's owed to you, if you forget to restore your withholding back to proper levels, you could wind up owing California taxes and penalties next April 15. Also, do not change your number of exemptions using IRS form W-4, or you'll also reduce your federal withholding and could run into under-withholding trouble with Uncle Sam next year.

You may want to consult your tax adviser to help you with this, but here's the four-step process if you want to do it yourself:

1. Use the calculator on the California Franchise Tax Board Web site to figure out how many exemptions you need to add to temporarily reduce your paycheck state withholding to zero, so that you can take back an amount equal to this year's refund as quickly as possible.

2. Fill out California FTB Form DE-4 to change your number of exemptions, and file it with your employer.

3. Keep close track of how much state withholding you're collecting. Once you've collected the amount owed to you, use Form DE-4 to switch your state withholding back up to what it was before you reduced it.

4. Properly endorse California's I.O.U. and send it back to Sacramento to pay the required 2009 withholding that you just pocketed as legal tender. Use FTB Form 540-ES to submit the I.O.U. as a 2009 estimated tax payment.–Jeff Blyskal