I will be itemizing for this year's taxes (2009 sched A) and will include a deduction for paid local taxes. However, I will be getting a refund of withheld state taxes.
What is the simplest way to avoid future correspondence (which always fills me with dread) with the IRS?
I am afraid that if I do not claim the state taxes on the 2009 Schedule A, when the IRS gets the copy of the 1099G from the state they will ask me why I didn't include that amount on the 2010 Form 1040. I can explain, of course, but I REALLY don't like having to explain things to them, since only SOME of the people there seem to have a brain (prior experiences).
Should I include the state taxes in the schedule A deduction and then just include the tax refund on the following year's Form 1040, when I get the 1099G from the sate?
You paid state taxes (through withholding) during 2009. If you itemize, that amount can be added in to the total on Schedule A for 2009.
If you get a refund of some of those taxes, it won't come until sometime in 2010, along with a 1099-G for 2010 (received in early 2011), so this refund of 2009 over-withholding does not affect your 2009 return at all, only possibly your 2010 return (to be filed in spring 2011).
By the same token, if you received a refund earlier this year (2009) of taxes withheld in 2008, then you will get a 2009 1099-G early in 2010, in time to do your 2009 taxes.
Since it's always a 2-year window, let's just say Year 1 and Year 2.
It basically works like this: if you got any benefit from deducting the taxes in Year 1 via itemization, but got some of the deducted taxes back as a refund in Year 2, it goes back into income in Year 2 (in most cases; there are exceptions where only some or none of it is taxable). This is to "undo" the excess deduction you took in Year 1 (deducted more taxes than you really owed, even if that wasn't your intention -- you didn't know until after Year 1 was over what your final state tax liability was).
If you didn't itemize in Year 1, then you definitely didn't get a tax benefit, so any refund you get in Year 2 is not taxable (has nothing to do with whether you itemized or not in Year 2).
So once again: excess deduction in Year 1 (if any -- can't be determined until after Year 1 is over), taxable refund in Year 2. No deduction in Year 1, refund not taxable in Year 2.
I can't think of any common reason why you *wouldn't* want to claim state tax deduction on your Schedule A.
The IRS could ask you, but they almost never do. First, they have your prior return and can see for themselves whether or not you itemized in
2009. Second, it is very common for state tax refunds to not be taxable, so that alone will not trigger any alerts in the IRS computer.
A professional tax preparer or do-it-yourself software will normally provide a worksheet showing the amount of your state tax refund that is taxable income in Year 2, after information for Year 1 is input.
Normally, yes, that is what you would do. There are lots of twists, turns, and exceptions if you are subject to AMT, or if your itemized deduction is not significantly larger than standard, or if you optionally deducted state sales tax instead of income tax, etc.
Refund of state income tax paid must be included on line 10 of form
1040.
10 Taxable refunds, credits, or offsets of state and local income taxes (see page 23)
There are times when you can leave line 10 blank even though you received a refund.
Is the state tax refund that you speak of received in 2009? Is it a refund of overpayment of state income tax on the 2008 state tax return? In your 2008 federal tax return, did you take the standard deduction or did you itemize? And if you itemized, did you claim the state income tax deduction? And did you have any AMT?
45 Alternative minimum tax (see page 40). Attach Form 6251
Any state income tax paid in 2009 will be reported on the 2009 Schedule A, along with any local tax paid.
The IRS will be right to ask you. Seems you are thinking of a scenario like this: in 2009 you receive a state tax refund of $2000 for overpayment of 2008 state income tax, in 2009 you also pay $10000 in state income tax.
So you're thinking whether to report 2k income on line 10 of form 1040 and 10k deduction on Schedule A, or alternatively to just report a deduction of 8k on Schedule A. The correct answer is that you have to use the first method. This method increases your AGI, and the IRS likes this because a higher AGI means you're less likely to qualify for the first time home buyer credit, stimulus checks, adoption credit, medical expense deduction, etc. In addition, with a higher AGI the phaseout of your itemized deduction is higher, and your AMT exemption is lower. And furthermore, if you're paying AMT, you don't receive any benefit for deducting the 10k of state income tax you paid
-- so it would have been nicer to just deduct 8k and leave the 2k out of your AGI, but the law does not allow this.
That is the proper treatment for cash-basis taxpayers.
You get the deduction in the year you PAY the taxes. If you get a refund, then you include the refund in income if you itemized (and had a tax benefit) in the previous year.
This is all standard and shouldn't generate any correspondence.
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