As a government civilian employee, if DFAS pays you too much in any given year and then later collects the amount back from you, there can be no way to recover up to $960 income tax you already paid on the amount. This could happen, for instance, if a time card is filed incorrectly and later corrected to show less work hours. As a big government bureaucracy, it seems DFAS is particularly prone to correcting what has already happened.
From the IRS’ point of view, you were paid the salary in the previous year, so you owe taxes on it for that year, a.k.a. “you can’t change history”. If the amount is taken back from you in a later year from your employer, that is your problem, and the IRS does not recognize “negative” income in the future year. The IRS does not allow you to file a corrected W2 for the previous year on the earned amount for income tax reasons, and they do not allow current year income to be offset by the amount collected.
* If the overpaid amount is $3000 or more, the IRS does allow a tax credit in the future year. See “Repayments” in IRS Pub 525 for how to do a “claim of right”. Basically, you calculate your taxes both with the amount and without it and claim the difference as a credit on the future year.
* If the amount is less than $3000, you can file the amount on a Schedule A Itemized Deductions. This is purposeful only if deductions exceed 2% of your income and exceed what your standard deduction would have been without itemizing. Example 1 Example 2 Example 3.
* The IRS does allow you to file a corrected W2 to correct social security and Medicare wages and taxes (but less income tax is not allowed). Realizes this hurts you because your social security earnings for that year would go down. See IRS Pub 15 Circular E pg 34, which gives instructions to employers. Let me interpret: corrections are made so your future Medicare and social security benefits are less, but corrections are not made to refund you any taxes.
If you don’t itemize with the IRS and your corrected amount is less than $3000, you’re stuck. You cannot get back the Federal or State tax. Assuming a 25% Federal tax and 5% State tax and a 2% city tax, that could be 32% of $2999.99, or $960.00.
Compounding this problem is that DFAS is very – v e r y – VERY – slow about getting any paperwork correct. Chances are it will take them 6 months to figure out that they need to collect from you and another 6 months to actually do the collection. It is easy to roll over to the next year.