State Film Credit

[Kram BergGold]

My client, a schedule C filer, earned a MA state film credit in 2012. The credit first wiped out her 2012 tax liability and then in 2013 she turned it into the state for 90% of the remaining value. The state reported this to the IRS on a 1099-G. I agree that the amount that reduced her 2012 taxes to zero belongs on Form 1040 line 10. The question is where does the rest of it go and any suggestions on how to handle this. The amount on the 1099-G is about $130k.

[Koss]

Film Credit

Geez, Mark, you get some d**n strange stuff...

Is your client an individual, or a business entity?

Did you prepare the 2012 tax return? If not, have you reviewed every page of the 2012 tax return?

It seems to me that this thing is actually a refundable tax credit. It is claimed on Schedule RFC. If your client received the check in 2013, then it may in fact be considered a state tax refund.

Does your client's 2012 state tax return contain Schedule RFC?

BMK

[Koss]

Form 1099-G

Okay, I didn't read your original post carefully enough. You stated that she is filing Schedule C, and you referred to line 10 of Form 1040, which is where we would normally enter a state tax refund. So you have answered my question about whether your client is an individual or a business entity. She is both.

If the refundable credit was claimed on Schedule RFC of her 2012 state tax return, then she would have received the money during 2013.

If that's what happened, then I stand by what I just said: It does indeed appear to be a state tax refund.

But that doesn't mean that the entire amount is taxable income on line 10 of Form 1040.

There is a mind-bending worksheet that is used to determine whether a state tax refund is taxable on the federal return. The general rule is that it is not taxable if the taxpayer did not itemize on the previous year's return. But even if they did, in some cases, only part of the state tax refund is taxable on line 10.

I think this is one of those cases...

BMK

[Koss]

State Tax Refund

If my interpretation is correct, then you may be able to use the worksheet for line 10 in the instructions for Form 1040 to determine what portion of the amount on Form 1099-G is taxable on the federal return.

Or you may have to use Worksheet 2 in IRS Publication 525.

I'm not kidding. You can't make this stuff up.

http://www.irs.gov/publications/p525/ar02.html#en_US_2013_publink1000267475

BMK

[Kram BergGold]

Burton

We don't have a form RFC in our state. Here is my problem. From doing some reading it appears the entie amount is taxable. 12k as a state refund of the 2012 taxes. The rest over 120k as maybe short term capital gain. My issue is all $132k is on the 1099-G. I called a man in the DOR and he said we put it on a 1099-G and that is that. My fear is the IRS is going to freak when I put $12k on line 10. I know if they look at Schedule A they will see that we dedcuted $18 k there. The extra 6,000 was state tax paid in 2012 for 2011. This was not refunded so it does not go on line 10. I guess I will just have to attach an explantion, which we know no one reads and then wait for the audit.

[Koss]

Tax Credit

We don't have a form RFC in our state. Here is my problem. From doing some reading it appears the entie amount is taxable. 12k as a state refund of the 2012 taxes. The rest over 120k as maybe short term capital gain.

If you have some authority for the claim that it is treated as capital gain, I would be curious to see it.

Massachusetts does have a tax form that is used to claim the credit. It is Schedule RFC:

http://www.mass.gov/dor/docs/dor/forms/inctax12/addl/sched-rfc.pdf

BMK

[Gary2]

If you have some authority for the claim that it is treated as capital gain, I would be curious to see it.

Massachusetts does have a tax form that is used to claim the credit. It is Schedule RFC:

http://www.mass.gov/dor/docs/dor/forms/inctax12/addl/sched-rfc.pdf

But don't be shocked if the software doesn't support it.

I vaguely recall reading that the reason state's refundable EITC isn't taxable at the federal level is the general welfare exclusion. I think it would be difficult to argue that the same principle applies to business-related refundable credits.

[Koss]

Refundable State Tax Credits

I think Gary2 has hit the nail on the head...

Capital gain treatment is applicable only when the original recipient of the tax credit sells the credit. This issue was addressed in Tempel v. Commissioner, 136 T.C. 341 (2011).

When the credit is used by the original recipient, it is either nontaxable, or it may be construed as ordinary income, as suggested by Gary2.

This may be an unsettled area of federal tax law. There is an excellent discussion of this in a recent newsletter published by KPMG. It says, in pertinent part, that:

- - - -
It is not clear whether the use of a refundable state tax credit by the original recipient would produce taxable income to the extent the credit exceeds the original recipient’s state tax liability. In general, state tax credits can be regarded as simply targeted reductions in state tax rates; and a reduction in state tax rates does not create income. But a refundable tax credit functions as a grant program. Governmental grant programs can result in taxable income, although the grants can also be excludable from gross income under, for example, precedents dealing with grants to promote the general welfare.
- - - -

This appears in a 20-page report on state income tax credits published by KPMG in April, 2013, and it addresses, among other things, credits for film production.

Here's a link to the report:

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&ved=0CCoQFjAB&url=http%3A%2F%2Fwww.kpmg.com%2FUS%2Fen%2FIssuesAndInsights%2FArticlesPublications%2Ftaxnewsflash%2FDocuments%2Fwnit-apr8-state-tax-credits.pdf&ei=ZuwPU4TAFKSg2AWcvIHYAw&usg=AFQjCNEe4VjB3KPOZSv-G93NRP0pukvYww&bvm=bv.61965928,d.b2I

After the ruling in Tempel, the IRS published Chief Counsel Advice 201147024, which you can find here:

https://www.conservesc.com/documents/Memorandum201147024.pdf

But all of this deals primarily with the sale of tax credits. There is no clear answer on the treatment of a refundable tax credit when it is used by the original recipient.

BMK

[Burke]

We don't have a form RFC in our state. Here is my problem. From doing some reading it appears the entie amount is taxable. 12k as a state refund of the 2012 taxes. The rest over 120k as maybe short term capital gain. My issue is all $132k is on the 1099-G. I called a man in the DOR and he said we put it on a 1099-G and that is that. My fear is the IRS is going to freak when I put $12k on line 10. I know if they look at Schedule A they will see that we dedcuted $18 k there. The extra 6,000 was state tax paid in 2012 for 2011. This was not refunded so it does not go on line 10. I guess I will just have to attach an explantion, which we know no one reads and then wait for the audit.

I am thinking they really should have issued 2 1099-G's, one for the refund and one for the buy-back. Capital gain is the correct treatment. It is much like other state credits, which if sold and not used, becomes taxable income, unless specifically exempted by state law. You said it was earned so I am assuming he has no cost basis. If he had purchased it from another entity, he would have a basis. Whether it is short-term or long-term depends on how long it was held. I wouldn't worry too much about the IRS match. Total income reported will be the same.

[Koss]

Tax Credit

I am thinking they really should have issued 2 1099-G's, one for the refund and one for the buy-back. Capital gain is the correct treatment. It is much like other state credits, which if sold and not used, becomes taxable income, unless specifically exempted by state law. You said it was earned so I am assuming he has no cost basis. If he had purchased it from another entity, he would have a basis. Whether it is short-term or long-term depends on how long it was held. I wouldn't worry too much about the IRS match. Total income reported will be the same.

I'm not convinced that it qualifies for capital gain treatment because I don't think it was a "buy-back." I also don't think the taxpayer "turned it in to the state for 90% of the remaining value," even though this is what the original post says.

I think the taxpayer simply claimed a refundable tax credit on her state tax return. She did not sell anything, and the state did not buy anything back.

She received a very large state tax refund, because she used a tax credit, and the state law says that up to 90% of the credit can be refunded.

It is a state tax refund. Period.

That doesn't answer the question of whether it is taxable. See Gary2's comments above, and my response.

The credit is for film production, and it is based on economic benefits to the state, including, among other things, job creation. It could arguably be tax exempt under the "general welfare" concept...

BMK

[Burke]

I'm not convinced that it qualifies for capital gain treatment because I don't think it was a "buy-back." I also don't think the taxpayer "turned it in to the state for 90% of the remaining value," even though this is what the original post says.
I think the taxpayer simply claimed a refundable tax credit on her state tax return. She did not sell anything, and the state did not buy anything back.
She received a very large state tax refund, because she used a tax credit, and the state law says that up to 90% of the credit can be refunded.
.BMK

Clearly, a horse of another color if this is the case.