Calif. tax refunds and state IOU's (warrants)

For CA, the law on registered warrants is embodied in the CA Government Code starting at section 17200.

When the State Controller publishes the document that states they are payable on "date specified", they become negotiable to the payee. The payee can use the warrant to pay any debt to the state or the payee can take it to a bank and get it cashed. Then you have constructive receipt.

So if a California TP has a refund coming from the state, and requests a warrant rather than applying it to next year's taxes, this might push out the taxable income associated with the refund to a future date. Is that a correct understanding?

Steve

I am not aware of any CA proposal to either issue registered warrants or offer taxpayers the option to receive warrants in lieu of cash. I don't care to speculate on what CA may or may not do. All that being said, I don't think any state that finds itself out of cash would offer any taxpayer an option. Either you get your refund or you get an IOU.

I was not being clear.

What I meant is, under the scenario in which cash from the State is not an option, the TP has a choice of applying the refund to their 2009 taxes, or requesting what will likely be a warrant. Perhaps the former option would represent constructive receipt but the latter option would not.

Steve

There was a time, years ago, when California state employees were paid on IOUs rather than salary warrants because of a budget holdup. I can't remember for sure whether this was during my time as a California state employee (late 1970s-early 1980s) or perhaps during the budget crunch of the early 1990s. In any case, what I do remember is that one or two of the banks or credit unions announced that they would cash the IOUs, and the other banks quickly fell into line. The impasse did not last long, as I recall, but the banks took the risk that it would be prolonged.

I'm not sure what the banks would do today.

Katie in San Diego

Applying a refund to next year's taxes is the same as having received the refund and then making an estimated payment. As such, even though you never received any cash, you still have a state tax refund you would have to declare if you received the tax benefit for deducting state income taxes in the prior year.

If the St. of CA, is out of money and is sending IOUs for refunds, there is no constructive receipt. If you elect to apply a refund to next year's taxes, it seems to me it is no different different then if you received the refund and sent an estimated tax payment or received a negotiable IOU, endorsed it and paid your estimated taxes with it. As the State is crediting your account for the amount, I believe you would have constructive receipt of the refund even though you have not received any cash and there is no cash. The amount was made available to you for paying your 2009 taxes.

What 2009 taxes? Since I don't owe any yet, all I can do in 2009 (if I continue not to owe any) is to ask for a refund. Oops, again, no cash.

Seth

You need to reread the whole thread. We are discussing whether a "refund" of previously deducted 2008 state income taxes generates taxable gross income in 2009 if the state is out of cash.

^^^^ I should have written early 2010.

I know that.

Taxpayer overpays during 2008.

In 2009 he files.

Case 1: He asks for a cash refund, gets a non-negotiable note. That's not constructive receipt.

Case 2: He asks to have the overpayment applied to his 2009 taxes (2010 filing). There's a claim that's constructive receipt because it covers a debt he'd otherwise have to pay. My point is that there is no such debt and might not be (e.g. in January 2009 he moved out of state), hence that doesn't automatically cause constructive receipt.

Since there's no automatic constructive receipt in Case 2, choosing Case 1 does not cause constructive receipt.

For the person who stays in California and files for lower withholding, I agree, there's constructive receipt.

Seth

Seth wrote: [snip]

I disagree. When you ask a state to apply a 2008 refund to next year's taxes, it is treated the same as you having received the refund and then made an estimated payment. Upon filing your 2009 return, you would have to report the refund (even though you never received any cash) as federal taxable income if you received the full tax benefit for deducting state income taxes on your 2008 tax return. This is true whether you remain a resident or don't remain a resident of the state in question. It is true whether you have a new tax liability to that state or not.

If under the hypothetical situation we have created (CA issues registered warrants (IOUs) for refunds), there is no constructive receipt until such time that the IOU becomes negotiable and there would not be any refund to report on the 2009 federal return if the IOU was still not negotiable by year-end 2009. If one elects not to receive the IOU but asks the state to apply the refund against 2009 taxes and the state credits your account. You have effectively made a 2009 state income tax payment to the state and you have a taxable refund that must be declared on the federal return. It doesn't matter whether you left the state or have no tax liability to that state. You could file a 2009 nonresident return to obtain a refund of your tax payment.

I don't see how you would not have constructive receipt of a refund if the state credits your account with a tax payment.

Right, that was my question. Is that latter situation constructive receipt if everyone else is getting warrants?

I would say an unfunded bookeeping entry is never income. It's analogous to deferred compensation.

Steve

One clear situation in which you would not have constructive receipt would be if that state stated, "These credits are unfunded until some future budgetary event, at which point we will let you know we have funded them." If that event does not occur until 2010, then there is no constructive receipt in 2009. After all, if the state declares bankruptcy (something no state has done since the late 1800's), those tax credits become worthless and you will still owe new taxes to the reorganised state.

However the more likely scenario is that the state will act as though the credit is there all along, and will never go bankrupt, in which case non-receipt is not as certain. This is why I'm proposing that it may be advantageous for TP to ask for the refund (i.e. the warrant), to clear this uncertainty.

Steve

Why? You'd received a *credit to your state tax account*. Since, by hypothesis, that credit is *not convertible into cash* I don't see why constructive receipt applies.

But that's not a cash account, it's the same sort of maybe-will-be

-money-sooner-or-later as the warrants.

Because it's not a cash account.

Another interesting case: the state says that the warrants are transferable, and may be used by anyone to pay state taxes. A market immediately springs up, with the warrants trading around $.98/$1.00 (98% of face). If Joe Taxpayer sells his $1,000 warrant for $980, how is that treated for Federal Income Tax purposes?

Seth

I'll try one more time.

A state issues you an IOU instead of a check for a refund of state income taxes. You can't cash it. But, you can use it to pay the state if you owe them any money or want to buy something from the state. Upon receiving the IOU, you are not in constructive receipt because there is a substantial limitation and restriction. You endorse the IOU and give it to the state to pay estimated taxes. Once the state accepts it, you are in constructive receipt of the refund because the IOU became negotiable for the purpose you used it for. It was accepted for payment. If you owed the state money (not a tax debt) and you endorsed the IOU and gave it to the state for payment and they accepted it, constructive receipt of the IOU happens. If you turn down the IOU and just say use my refund for my 2009 taxes.. you have effectively accepted the IOU.. endorsed it.. and made a payment of income tax. I don't see any difference.

If you hold unto the IOU until the State announces it is freely negotiable and you can then cash it at the bank.. you would have constructive receipt then.

I do not think California plans to let you use the warrants to pay estimated taxes, until the warrants are declared good. That is my recollection from the last time they did this.

I could be wrong though.

Steve

CA has not made any formal announcement. This is all hypothetical.

I see nowhere on the CA tax form to even allow you to apply a refund to next years taxes. You can do that on federal but not CA. Even if they changed the law to allow that, the forms (and tax programs) are already out and people are filing as we speak.

I don't know where you are looking, but every 540 I have seen has a line under the computation of the overpayment that asks how much you want to apply to the next year's estimated tax. You must be looking at the end of the return where it asks for the direct deposit info. You have to look at the section where the overpayment is computed. That section is before the Use Tax and voluntary contribution section.

OK, got it - line 46. Must have read right past that.