North Carolina Mess

[erchess]

Married couple filed jointly in 2010 as they have throughout their long married life. Their NC return for 2010 showed an overpayment of roughly 10K of which they insisted that I ask that 2K be retained by the state and applied to their 2011 taxes. Their bank records show a direct deposit in 2011 consistent with their request being honored. However the card they got in 2012 saying how much refund they received in 2011 is consistent with the request not being honored. I didn't notice the discrepancy and filed a 2011 return showing the $2K in estimated taxes, most of which was due back but showing tax of a single digit number. Complicating things, the 2012 returns were MFS. I did not make any mark in the software to indicate that the ES was joint even though the returns are separate. NC has written about the taxpayer's return but not about spouse's. NC says has no record of the estimated payments for 2012 but also feels there is no tax due and return has zero bottom line.

I will talk to my software company about what I could have done differently but the more immediately pressing question is what to do going forward. What does anyone have by way of advice?

[JohnH]

The card advising of the refund should have shown $10K, because that's what they actually received as a refund. The fact that they applied $2K to estimated tax for 2011 just means they have a $2K deduction on the 2011 return.

I'd beging by sending the State of NC a copy of the bank statement showing the $8K deposit, a copy of the card showing the $10K refund, and a copy of the 2010 return. Ask them to explain what happened to the $2K.

[FEDUKE404]

NCDOR is correct

Married couple filed jointly in 2010 as they have throughout their long married life. Their NC return for 2010 showed an overpayment of roughly 10K of which they insisted that I ask that 2K be retained by the state and applied to their 2011 taxes. Their bank records show a direct deposit in 2011 consistent with their request being honored. However the card they got in 2012 saying how much refund they received in 2011 is consistent with the request not being honored. I didn't notice the discrepancy and filed a 2011 return showing the $2K in estimated taxes, most of which was due back but showing tax of a single digit number. Complicating things, the 2012 returns were MFS. I did not make any mark in the software to indicate that the ES was joint even though the returns are separate. NC has written about the taxpayer's return but not about spouse's. NC says has no record of the estimated payments for 2012 but also feels there is no tax due and return has zero bottom line.

I will talk to my software company about what I could have done differently but the more immediately pressing question is what to do going forward. What does anyone have by way of advice?

I do not see any problem with what NCDOR reported.

If they were entitled to a refund of $10k for tax year 2010, the Form 1099-G for calendar year 2011 should show the full amount of the $10k refund. There is no way you can conclude, from the Form 1099-G, that "their request was not honored." Whether they applied nothing to 2011 estimated taxes, or the full amount to 2011 estimated taxes, the "card" would (rightfully) show the same $10k refund amount.

Many of my clients will apply a portion of their NC refund to the following year estimated taxes. The Form 1099-G always has shown the gross amount of the calculated refund, and never the "net" amount of funds returned to the taxpayer.

If your clients wanted to apply some of that refund to the 2011 state estimated taxes, that is a completely separate issue. It never has any impact on the amount of the "refund" although, after you enter the appropriate data into your software, it is likely something less than the full amount of the $10k refund will appear on line 10 of Form 1040.

I would carefully review the efiled return for 2010, to be sure that you did request some of the refund to be applied to estimated tax. I cannot realistically imagine a properly entered item on an efiled return would not process. OTOH, if you went with a paper return, a data input error could have occurred.

Assuming the $2k did go to estimated taxes, the NCDOR people should easily be able to "find that" and assist in treating the funds as being "his" or "hers" or whatever you wish.

As for your "software company" I doubt if there is much they could do. I have never seen an instance where a refund (federal or state) from a jointly filed tax return could be specifically allocated to either the husband or the wife. (My guess is it goes to the primary taxpayer on the return?) If you were in that situation, you likely should have paid separate estimated taxes for H/W, using a single SSN, and had the full amount of the original "joint" refund returned intact.

FE

[Snaggletooth]

Credits and Offsets

Erchess, I wish you were correct - it would make tax planning much easier. The taxable line on the Federal return used to read "State Tax Refunds". Now it reads something like
"State tax refunds, credits, offsets, overpayments, etc."

The FULL AMOUNT of the overpayment (whether they chose to receive it or not) is taxable on this line. However, for any portion they chose not to receive, that portion is eligible for a state tax deduction on Schedule A.

Overpayment of $10,000 with only $2,000 received and $8,000 applied? The full $10,000 is reported as income, but $8000 is added to the State income tax deducted on Schedule A. Is this a fair shake? No, for many reasons. You don't want an inflated AGI for many reasons, PLUS adding $8K to Schedule A taxes can end up as extra taxation for the Minimum tax.

[Gary2]

... PLUS adding $8K to Schedule A taxes can end up as extra taxation for the Minimum tax.

But the $10K would be excluded from income for the AMT.

[FEDUKE404]

Not necessarily fully taxable

Erchess, I wish you were correct - it would make tax planning much easier. The taxable line on the Federal return used to read "State Tax Refunds". Now it reads something like
"State tax refunds, credits, offsets, overpayments, etc."

The FULL AMOUNT of the overpayment (whether they chose to receive it or not) is taxable on this line. However, for any portion they chose not to receive, that portion is eligible for a state tax deduction on Schedule A.

Overpayment of $10,000 with only $2,000 received and $8,000 applied? The full $10,000 is reported as income, but $8000 is added to the State income tax deducted on Schedule A. Is this a fair shake? No, for many reasons. You don't want an inflated AGI for many reasons, PLUS adding $8K to Schedule A taxes can end up as extra taxation for the Minimum tax.

This is an incorrect statement.

The full amount of the state refund is NOT necessarily taxable income, even if the client itemized for the applicable year. There are valid adjustments to reduce the amount to be reported on the front page of the Form 1040. Such adjustments can be a result of state estimated tax payments made (what/when) and also the taxable amount can be reduced when factoring in the allowable "standard" amounts from the state sales tax tables. (You DO regularly fill that information in, don't you?)

I've had many clients, as well as myself, where the taxable amount of the state (NC) refund is lower than the amount shown on the little white card from NCDOR. Most tax software now includes a detailed worksheet. Look around for such and/or "recovery exclusion" issues.

You can review page 22 (middle column) of Pub 525 (http://www.irs.gov/pub/irs-pdf/p525.pdf for more information and related worksheets.

FE

[JohnH]

Part of this is news to me. I understand that the state tax refund shown on the W2-G is ignored entirely for a non-itemizer in the prior year, and might be reduced for an itemizer for any number of reasons. This could result from a slight difference in state tax deduction vs sales tax deduction, borderline itemizers, and a few other more esoteric factors.

But I've always operated under the understanding that applying part of the refund to estimated tax for the upcoming year would not reduce the state tax refund shown on the front page of the 1040 when the upcoming year's return is filed. My practice has been to report the entire taxable amount of state tax refund on line 10 of the 1040 and then take the appropriate deduction on the Schedule A.

Hopefully we will have some more discussion about this. Even though it might not affect AMT, it would matter when the taxpayer has deductible medical expenses or employee business expenses.

[FEDUKE404]

Taxable amount of state refunds

Part of this is news to me. I understand that the state tax refund shown on the W2-G is ignored entirely for a non-itemizer in the prior year, and might be reduced for an itemizer for any number of reasons. This could result from a slight difference in state tax deduction vs sales tax deduction, borderline itemizers, and a few other more esoteric factors.

But I've always operated under the understanding that applying part of the refund to estimated tax for the upcoming year would not reduce the state tax refund shown on the front page of the 1040 when the upcoming year's return is filed. My practice has been to report the entire taxable amount of state tax refund on line 10 of the 1040 and then take the appropriate deduction on the Schedule A.

Hopefully we will have some more discussion about this. Even though it might not affect AMT, it would matter when the taxpayer has deductible medical expenses or employee business expenses.

John -

FWIW, TTax has a very nice set of worksheets (look for "St Ref Wks"). Adjustments to taxable refund amount can be made for calendar year cross-overs (#4 state issues) estimated tax payments/extensions ("refund allocated to....") . There is also an entry-point for "Enter the amount of general sales taxes that could have been taken...."

I too remember the days when some green-box folks told me it was "all or nothing" as to the taxability of a state refund if a client had itemized. (We later had some spirited "but, what if...??" discussions.)

The easy way out is to make everything taxable, and just move onward. The above cited worksheet even has a box you can check to "ignore" the worksheet, thereby making the full refund taxable. Kinda depends upon your personal attitude toward such. You should also note that use of the worksheet will modify some of the "same" numbers that would otherwise appear on Schedule A, line 5. (You can't "deduct" the same amount twice!) Use of such an approach does require a full preparer understanding of the issues involved to be able to respond to any "But I paid $x in state estimated tax and you only deducted $y !!!" scenarios.

My suggestion would be, for at least a few clients, to do some of the adjustments (especially the "allocation" type) by hand to get a feel for the internal calculations. Maybe even, gulp, resign yourself to endure the Q&A from the software. And then use the on/off switch to see what effect the worksheet may have. Sometimes....you get the same overall result either way.

But IRS Pub 525 and available software (especially for a returning client where "the numbers" are already there!) certainly give you other options that frequently can work in the clients best interests..... A common outcome is the client may actually be able to deduct more medical/business expenses, put more funds into IRA accounts, etc as a result of the reduced AGI that can occur.

FE

[Snaggletooth]

This is an incorrect statement.

The full amount of the state refund is NOT necessarily taxable income, even if the client itemized for the applicable year.

FED I believe we are aware that several circumstances can void the taxability of a state refund, even if the taxpayer itemizes.

Not disputing the accuracy of your response, but a perfect example of how a simple response can be mushroomed into so many different winding roads that the original post loses its thought process. The original post assumed a taxpayer can choose to limit his taxability of an overpayment to the amount actually received, and I hope it is understood that the entire overpayment has to be dealt with.

[JohnH]

FE. Glad you bought this up. No question that the full amount of the prior year refund is not always taxable - that fequently happens. I have a few I'll play around with in the coming weeks to see if there's a situation where ATX will reduce the taxable amount of the prior year refund (regardless of what that amount may be) by the estimated tax payment. On that specific issue I remain unconvinced, but am willing to change.

[Lion]

I left Block long ago, but that's not what I was taught, FE. In fact, our classes and our updates stressed the things that could make the taxable amount of a state refund less than the total refund, especially after state sales taxes came to be deductible. AMT was another calculation Block taught, and one the software made if we already had or entered prior year information. If only part or none of the prior year state income taxes were a benefit due to AMT, then the current year taxable amount would be lower than reported on Form 1099-G. I remember my very first year seeing a smaller number on page one than I was expecting, and jumping to the worksheet to follow through the calculations. From then on, I paid a lot of attention to that worksheet to make sure my clients didn't pay more tax than they should.

[Burke]

On that specific issue I remain unconvinced, .....

As I am also.

[erchess]

I may have been unclear

It was not my intent to discuss how much of the previous year's refund is taxable. My problem is that we asked in the previous year for 2K of overpayment to be kept and applied to the 2011 estimated tax and this was done yet for some reason the NCDOR is not recognizing the estimated tax payment. I still think there could have been some way for me to tell NC that last year they filed a joint return and as far as I know I failed to tick that box or whatever.

As to the amount of the refund that's taxable, Drake automates the calculation if you enter the correct data from the prior year return. I do think the wording on the screen is unclear at best but once tech support cleared things up for me the process was easy and fun. I am old and forgetful so I have that convo with tech support early every year.

[FEDUKE404]

Worthy of review?

As I am also.

At the risk of again being accused of hijacking/mushrooming this thread....

Suggest you peruse page 22, right column ("Recovery for 2 or more years") of IRS Publication 525 ( http://www.irs.gov/pub/irs-pdf/p525.pdf ).

The example shown on pages 22/23 seems reasonably on point, at least to me, as it appears to address the issue of determining taxability of a state refund when state estimated payments for year 20xx were made in more than one calendar year. The IRS instructions even state the need to attach a statement to show why the line 10 amount on Form 1040 is less than that shown on the Form 1099-G.

Yes, I agree this is a different issue than the plain vanilla "$10k less $2k" original post, and for the record I never mentioned any AMT considerations at all.

Someone may wish to discuss some of the issues raised here in a replacement thread?

Sorry to have been such a pest. . . . . . . . . . . .

Elvis is now leaving this building.

FE

[JohnH]

FE : You're not being a pest. This is something which could matter.

It probably doesn't make much differnce when the amounts are relatively small, but in cases where the applied amount is large, it could have significant effect. I havent had a chance to run some scenarios, but I plan to do so at some point.