Difference between Tax exempt Interest and Tax exempt dividends?

My son sent me his H&RBlock file to check his return before he filed.

He has tax exempt interest and tax exempt dividends. For the interest the software asked how much of it was tax exempt in his state. It didn't ask that for the dividends, though it should have.

I spent 2 hours with H&RBlock customer service before discovering that the problem was that he incorrectly said he was a part year resident of California, when he should have said he was a full year resident! Correcting that fixed the problem; apparently dividends can only be state tax exempt for full year residents.

Are tax exempt interest and tax exempt dividends treated different with respect to part year residency? Seems unlikely, but who knows...

Reply to
veryfrustrateduser
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You're looking at it the wrong way. "Part year resident" is just a shorthand way of saying, both "resident for part of the year" and "non-resident for part of the year". Then, all you need are the rules for residents, rules for non-residents, and a dividing date, and you're all set.

A CA resident is taxed on world-wide income. A non-resident is taxed only on CA source income. Dividends and interest are sourced to the state of residence, so a non-resident would have no CA source tax-exempt (muni) income. However, to complete the CA non-resident return, the non-resident must first calculate their tax is if they were a resident, so they must apply the same rules as a resident, in that step of the process.

Nowadays, don't tax-exempt dividends end up reported on the interest portion of the Schedule B/Form 1040 anyway?

Reply to
Mark Bole

We are actually discussing what is called "exempt interest dividends". These are sourced from mutual funds and a bunch of other types of RICs. They get reported in Box 10 of the 1099-DIV. They will feed Line 8b of the 1040. This is the same line for tax exempt interest.

Most of the software I am familiar with have you enter this information on the dividend worksheet/statement as the source document is a 1099-DIV or substitute 1099-DIV.

Reply to
Alan

You are correct, both the interest and the dividends go to line 8b of 1040.

Both are tax free for the federal return and also the state return if the bonds are from the state of residence. Right?

But the tax software asked me if the interest was tax free for the state, but never asked about the dividends; it just assumed they were not.

It turned out the reason it did not ask is because my son mistakenly said he was resident for part of the year, and the tax software believes the dividends can only be tax free for full year residents.

Yet it did ask me if the interest was tax free for the state, despite the mis-entry regarding residency.

I would expect them both to be treated the same, but they aren't.

So my question is whether the tax software is wrong (and if so, how) or are interest and dividends really treated differently as the software seems to think.

Reply to
veryfrustrateduser

I can't discuss your tax software. The professional software that I use allows me to code that which is federal tax exempt and that which is tax exempt for the state of residence. I don't use the software interview method for preparing returns. Exempt interest dividends that source from the state of residence should be treated no differently then tax exempt interest that has the same source.

However please note that each state is free to decide on how you make the determination that an amount of exempt interest dividends are free of state taxes. For example, here are the CA rules:

Certain mutual funds pay ?exempt-interest dividends.? If the mutual fund has at least 50% of its assets invested in tax-exempt U.S. obligations and/or in California or its municipal obligations, that amount of dividend is exempt from California tax. The proportion of dividends that are tax-exempt will be shown on your annual statement or statement issued with Form 1099-DIV, Dividends and Distributions.

Note the 50% threshold. Other states may allow you to use the exact percentage in the information statement you receive.

Reply to
Alan
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You still seem to be hung up on the residency issue, not the rules about how states handle exempt interest dividends.

Part-year resident returns are usually somewhat complicated, and I would not expect self-service software to handle every aspect smoothly and painlessly. This is one of those situations where consulting a professional is recommended.

I'll repeat my hint from before: for CA, a non-resident must first calculate their taxes as if they were a resident. Then they apply sourcing rules. Income from intangible investments, such as mutual funds, is going to be sourced to the state of residency at time received.

Reply to
Mark Bole

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