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Drake and other tax software: Add back of out of state sch e losses to state return

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    Drake and other tax software: Add back of out of state sch e losses to state return

    1. Question to those who do Michigan returns (or other states with a similar rule): Does your software automatically add back out of state Schedule E losses to compute Michigan (or other state's) taxable income? If so, what software are you using? This is prompted by some audits I am now handling this fall.
    2. Have three "audits" from two different tax offices in Michigan involving a Michigan add back of out of state schedule E losses to Michigan Taxable Income. (These are all 2010 return-4 year SOL in Michigan).
    3. Two of the returns were prepared by same firm using Drake software (and I am told it is their full version for whatever that may mean).
    4. The other was prepared by a "home office" guy who used some type of software on line. [He has used a different on line software since 2012, which apparently has the same issue.]
    5. All taxpayers are Michigan residents and all, independent of each other, have rental real estate in other states which show losses (or a loss) on Schedule E, Federal return.
    All claimed to be actively and materially involved in their real estate rental activities so that aspect is not an issue.
    6. Michigan tax law requires non-Michigan federal Schedule E losses claimed to lower Federal AGI to be added back to federal AGI in order to compute Michigan taxable income. (See p. 11 of Michigan's MI-1040 instruction booklet.)
    7. The Drake preparer showed me the data entry fields she used in preparing the two returns for which she had entered each rental property (in question) as being in a non-Michigan state. That generated an income tax return for those states (California and Ohio). However, no was there upward adjustment on the Michigan tax return. As you probably expect by now, the taxpayers have been audited by Michigan Treasury. Drake preparer did prepare non-Michigan returns and she thinks they were automatically triggered by how she entered the Schedule E rental properties.
    8. The Drake software did not 'carry forward' the out of state loss for the respective properties to the Michigan return as an add back to Federal AGI. As a result, each taxpayer either got a larger refund than they should have or had a lower tax bill to pay on the Michigan returns. (Amounts are between $500.00 and $1000.00 before interest/penalties).
    9. The home office guy didn't know what I was talking about and as he does returns using an on line version of some software and was unable to show me his work. The printed copies he keeps show the federal loss but no Michigan add-back. The other state was Indiana. (FWIW he didn't do the non-Michigan return either.
    10. Drake told Preparer 1 she had to manually enter Sch E losses into a Michigan schedule for additions (which she has not been doing). The home office guy had no clue but it appears whatever he was using that year didn't automatically do what was required for the Michigan return and he made no manual adjustments. [For those Michigan tax nerds reading this far, no MI-1040H (apportionment) was completed.]
    11. My concern is not with the preparers; just curious about the software issue. If this issue applies to you, do you have to manually enter Schedule E losses as an addition (add back) to the resident state return, or does your software do this automatically, and which software do you use or wish you were using?
    12. Incidentally, Michigan has the same type of requirement on the sale of business property located in another state (adding back losses if any) so I suspect the same type of problem/issue arises in those cases with Drake.

    Thank you.
    Friends double; family triple. Don't buy an audit for yourself. If someone has to go to jail make sure it is the client. Remember it is only taxes, nothing important.

    #2
    If I remember SC has a similar issue if you are a resident with rentals in other states. May need to check these states a lot closer than we have been instead of depending on software to do it.

    Comment


      #3
      State return variations are a problem.

      After using most of the tax software available I have come to realize that when you are dealing with state variations you just can NOT trust the software to do it correctly each time. Here in MA we have a lot of variations, like depreciation etc. It takes me almost twice as long to do the state return of a business taxpayer.

      When you have multiple states it is even worse!

      Any tax preparer who accepts a default state return tax calculation from a software without a manual checking is asking for trouble.
      Taxes after all are the dues that we pay for the privileges of membership in an organized society. - FDR

      Comment


        #4
        Drake-state variations

        Originally posted by ATSMAN View Post
        After using most of the tax software available I have come to realize that when you are dealing with state variations you just can NOT trust the software to do it correctly each time. Here in MA we have a lot of variations, like depreciation etc. It takes me almost twice as long to do the state return of a business taxpayer.

        When you have multiple states it is even worse!

        Any tax preparer who accepts a default state return tax calculation from a software without a manual checking is asking for trouble.
        Well stated as always. Thanks for responding to my post.

        My curiosity and reason for the post was when I read Drake's user manual there was no mention of this aspect. Drake's specific instruction for the particular data entry field are somewhat confusing: on the one hand, they instruct that any entry in the specified field overrides amounts attributed to other states from a Michigan Schedule NR (non Resident). It goes on to state that "included here are losses from business or property located in another state..... As none of the taxpayers here are part-year resident or non residents no schedule NR was prepared.

        The Drake preparer in my post read that and came away with the conclusion, which in hindsight is not correct, that the software was computing the out of state losses to be added back for purposes of Michigan Tax. The amounts of penalty and interest in her cases will total about $1200.00 (combined-both returns).

        Probably I should have stated that I use Drake, and for those clients with these out of state losses I manually enter the amounts of loss attributable to Michigan.

        Thanks again. Always enjoy and learn from your comments.
        Friends double; family triple. Don't buy an audit for yourself. If someone has to go to jail make sure it is the client. Remember it is only taxes, nothing important.

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