taxable portion of state tax refund

"Gil Faver" IRS worksheet):

First of all, please do not confuse logic or common sense with tax simplification. You have to allocate the disallowed itemized deductions to the various categories of itemized deductions claimed in the previous years. Determining just how much benefit the state & local tax deduction may require reruning the tax return several times with different sets of numbers to find out how much of the state & local tax deduction actually provided a benefit. The IRS may have a publication on topic. ___________________________________

-----> real address on hobokeni or hobokenx

"Gil Faver" IRS worksheet):

Because you didn't do it right.

Try this shortened form:

Itemized deductions actually taken: $54,000 Greated of itemized deductions if only actual state tax had been deducted, or standard deduction: $41,000 Tax Benefit: $13,000 ($54,000 - $41,000) Taxable state refund: $13,000

You're right. The State and Local Income Tax Refund Worksheet does not take into account the itemized deduction limitation. That's why you can't use that worksheet if your itemized deductions were limited in the previous year. Exception 9 in the instructions above the worksheet in the

"Gil Faver" IRS worksheet):

Because you were allowed $45,000 in itemized deduction and there state tax credit in the itemized deductions was $45,000. They just disallowed the other 9,000.

Yes, also true for about a half-dozen other situations where no prior-year tax benefit was derived. I like the one where your prior year AMT liability means you didn't get any benefit, but if you continue to have a sizable AMT liability in the current year, it doesn't matter, since state taxes are an AMT exclusion item anyway. But it's still probably worth it to get your AGI right, due to the many indirect effects of that number.

Correct -- both the 1040 instructions and Pub 525 indicate that the simple worksheet does not cover the special cases. Try Worksheet 2 in Pub 525 and the accompanying discussion there. I'm not surprised if tax software (not your question, but relevant) does not always cover every single scenario, after all what's the marketplace cost/benefit to doing so?

-Mark Bole

"Gil Faver" IRS worksheet):

Because you were allowed $45,000 in itemized deduction and there state tax credit in the itemized deductions was $45,000. They just disallowed the other 9,000.

No, that is not correct. See Chapter 29 of Pub 17. The following are subject to limitation: taxes, interest paid, gifts to charity, most miscellaneous deductions. So the $45K that was allowed did NOT include the full amount of the state and local tax deduction, the $9K that was disallowed DID include some of it. Therefore the amount of the refund will most likely only be partly taxable in the following year. It's not simple or straightforward. Please re-read the previous replies (some of which are also wrong).

-Mark Bole

But the limitation is based on total income, so it would be $9K even if the state income tax were lower. Seth

Using the OP's numbers, you're right. If his 2005 AGI was $445,950, then (and only then) would his itemized deduction limitation be $9K. In this case if he had only deducted the $32K actually owed for state tax, his total itemized deductions would be $41K, his limitation would still be $9K, and the full $13K refund would therefore be includable in taxable income. So to the extent that some of the previous replies were assuming an AGI of $445,950, they were correct. (That is, unless this taxpayer were subject to AMT -- we don't have enough information). The limitation based on an 80% reduction of affected deductions is not advantageous for this taxpayer unless his state tax deduction is reduced to about $11K. Suppose the original numbers were changed such that the state tax deduction taken was $11K, and the refund was $2K. Then only $400 (20%) of the refund would be taxable, since the rest of it would have been disallowed as part of the limitation. In 2006, the limitation amounts (either 3% of AGI or 80% of affected deductions) are reduced by one-third.

-Mark Bole

If the taxpayer had claimed only the actual state income tax owed none of the refund would be taxable. See section

WDK