Sch A - State Income Tax vs Sales Tax

[PIGLEE]

I understand the choice last year to deduct State Income Tax or State Sales Tax. What I still do not understand is what will happen in tax year 2005. If you chose the State Sales Tax deduction, and did not use the State Income Tax, what happens to your state tax refund. To me, it does not look like you have to add back into income, your State Income Tax Refund, because it was not a deduction in 2004.

What is your interpreation?? Has anyone heard about any new changes??

[dmj4]

Would have to be true.

That is what I was counting on last year in situations where the deductions were close. I don't see how they could make you add back to income, something that you did not deduct. Another reason is that states that do not have an income tax for every TP, got to take the sales tax deduction.

[Snaggletooth]

Worksheet

Folks, I think if you look at last year's worksheet for "Taxable State Income Tax Refunds" you will note a line item that calls for the SIT deduction for the year in question. If they do not change the worksheet, then this amount would be ZERO for those who elected the Sales Tax, and thus no taxation of the refund. As soon as the worksheet is published, check it out.

A better question might be in cases where the SIT provides a larger deduction than the SST, but taxpayers elect the SST anyway because they don't want to be taxed on the refund. In such a case, are you FORCED to take the larger amount?

Regards, Ron J.

[jainen]

tax refund

That is true. The tax refund is only taxable to the extent you received a tax benefit from it. Besides this sales tax option and the standard deduction, you can exclude refunds based on estimated taxes paid after year-end, limited by phaseout, etc. Good software should handle this common situation without fuss.

[Bees Knees]

Here is the theory. You are allowed a state income tax deduction. To make life simple, years ago the policy of allowing you to deduct state income tax under the cash method of accounting was adopted. Your employer withheld the state taxes from your pay check. Under the cash method, you deduct the total withholding since that is what you actually paid during the year. But, we all know the withholding amount is not the actual state income tax liability. If your liability is less than the amount withheld, you get a refund of those taxes paid in the following year. This of course means you deducted too much the previous year under the cash method. So to correct the matter, you would then add that refund to taxable income on the federal return, BECAUSE you deducted too much when you based the deduction on the withholding amount rather than actual tax liability.

Keep that theory in mind when you now consider the sales tax deduction. The law gives you the choice between sales tax or income tax. If you chose the sales tax deduction, what was it based on? There is no sales tax withholding. There is no possibility of overpaying your sales tax so that you get a refund in the following year. The cash method of accounting for sales taxes paid does not cause you to have to fix anything in the following year. You were able to calculate the actual sales tax liability at the time the tax return claiming the deduction was filed (or use the allowed amount from the tables).

State income tax refunds in the following year should not be considered, because you did not overstate your sales tax deduction based on any state withholding amount that exceeded liability. State withholding was thus not a part of the deduction calculated when the sales tax deduction was used.

So in other words, the state income tax refund is not included in income simply because no part of that refund was deducted in the previous year.