if a taxpayer anticipates a refund on a state tax return can the amount of schedula a deduction for state income taxes paid be adjusted for the anticipated refund, so no income has to be reported on the next year federal 1040 for the refund of state tax?
Dick Weaver wrote:
I think there is some confusion here between what is legal and what is practical or sensible . Legally, I would agree with Alan Kalman that the IRS doesn't care whether you claim all your allowable deductions or not. Deductions are allowed, not required. The state income tax refund is taxable income to you in the next year only if you got a tax benefit from it in the year you paid it. If you didn't deduct it in Year 1, you don't have to include the refund in income in Year 2. Now, of course, you will get a 1099G from the state showing the amount of the refund, and the IRS will have that information. So, if you itemized your deductions in Year 1, the IRS may have some questions to ask you. As long as you can show that you did not deduct all of the state taxes you paid in Year 1, so that you did not get a tax benefit from the amount that was refunded in Year 2, you will win that argument. However, you will put some time and energy into defending your position. Also, this strategy (barring a big difference in rates or your tax bracket) will increase your Year 1 taxes and reduce Year 2's by roughly the same amount. That's the reverse of the usual tax strategy, which is to postpone payment of the tax as long as possible based on the time value of money. Shorting the deduction in Year 1 in effect gives the government the benefit of the time value; it gets the money sooner. So I would say the answer to your original question is yes, you can do that. The question is why you would want to. It might make sense if you expect to be in a much higher tax bracket in Year 2 than in Year 1. Katie in San Diego
The foregoing is intended for educational purposes only and does not constitute legal or professional advice.
I wonder if this is a way for some to accomplish something the IRS has been fighting for years: income shifting from one year to the next. I've seen elaborate schemes, sometimes known as stradles, for that purpose, and most if not all have been declared illegal. But if someone just massively overpays their state income tax, will that work? The downside, of course, is that you are making a year-long, interest-free loan to the state government. I suppose that could eliminate much of the benefit of income shifting. Stu
(Referring to the strategy of only deducting the income taxes actually due in year 1, rather than deducting the income taxes paid and claiming the refund as a recovery.) ...
Unless you're subject to AGI phaseouts in year 2, in which case your year 2 reduction would be larger than your year 1 inmprovement....
I don't even think that it comes down to that. It is a matter of one's chosen ACCOUNTING METHOD. For those on the cash basis, what one has paid is his/her required withholding and estimated tax payments - so that is what gets deducted. For those on the accrual basis, it depends on what one is liable for and when. Some states, by statute, indicate that the tax accrues on January 1 (or the first day of the next tax year for those not on the calendar year), and other states indicate December 31. The outcome proposed in the original question is possible ONLY for accrual basis taxpayers in states that accrue the year's liability on its last day. The only state I have heard an answer to about this for accrual basis taxpayers is California. Back about 1974, CA changed the date from January 1 to December 31.
I disagree. There is no discretion permitted here to choose
- other than to change accounting methods.
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