Income tax refund recoveries.

I hadn't noticed this, and maybe some of you haven't either. Traditionally, for a recovery (including state income tax refunds), we're used to thinking that if a [cash basis*] taxpayer got a tax benefit from a deduction, he must include the refund as income in the subsequent year. However, the IRS threw in a "curve ball" starting with the state sales tax deduction. From Pub 525 (2010):

"If you could choose to deduct for a tax year either: - State and local income taxes, or - State and local general sales taxes, then the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you did not choose to deduct for that year.

"Example 1. For 2009 you can choose an $11,000 state income tax deduction or a $10,000 state general sales tax deduction. You choose to deduct the state income tax. In 2010 you receive a $2,500 state income tax refund. The maximum refund that you may have to include in income is $1,000, since you could have deducted $10,000 in state general sales tax."

This means that for every taxpayer, we now have to figure out the state sales tax deduction even when the income tax deduction is higher. Does your software do that? Maybe not, and especially not if one doesn't have a package that carries from year to year.

  • - An accrual basis taxpayer would not be deducting the amount paid in, only the amount owed, so his refund would not be a recovery.
Reply to
D. Stussy
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This is similar to the situation where the previous year's deduction incurred some AMT ... you have to compute it both ways for the previous year, to determine what part of the state income taxes deduction gained any tax benefit, and then in the current year you claim only that amount as taxable income.

I do not believe TurboTax (for example) does this AMT-related calculation automatically either (this question came up recently).

Steve

Reply to
Steve Pope

We use TaxWise, which does do this calculation for both the current year Schedule A and for computing the taxable portion of a refund. We have to manually provide the information from the prior year return when figuring the taxable recovery.

Phil Marti VITA/TCE Volunteer Clarksburg, MD

Reply to
Phil Marti

I don't see why you characterize this as a "curve ball" since it is a means by which the taxable portion of a state income tax refund could be lower than would otherwise be the case. Since the tax benefit rule already, in my opinion, allowed the use of this "curve ball," the IRS did us tax professionals (and our professional liabilty insurance providers) a favor by reminding us of what otherwise could have been a costly "gotcha."

Reply to
Bill Brown

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