MD tax on sale of real property

[Possi]

Hey,

My new client inherited her mother's house and sold it in 2007. It is in MD (I am VA) and there is a form showing Maryland Income tax withheld about $14000.

I'm filing the MD/NR return to get that money back, as I have already studied all that...

I am realizing that this money should be included on the Sch A for state tax withheld.

Any reason not to include this on the Sch A?

I am questioning myself because I know it's a large amount and it will also become INCOME on next year's return.

Thanks in advance to my extended office!
"I'VE got people!"

*smile*
~possi

[gkaiseril]

There are 2 schools of thought on this.

One is, if you do not include the state tax withheld on Schedule A then the refund in the following year would not be taxable since it was not deducted in determining the federal tax liability. Note this is also how the taking of the state sales tax rather than the state income taxes paid or withheld is being handled.

The second and most common is to claim the tax withheld by all states and localities and then report as income the state income taxes refund in the next year or the portion from the recovery tax refund recovery worksheet.

Do not forget if you are paying taxes to MD as a non-resident you should have a credit for the total tax liability for MD, no the taxes withheld, on the VA return.

Be carful about using other's service marks.

[Possi]

refunded taxes

I hear you on that, but here is why I thought it might be best to put it on the A this year... we are only filing MD return to get that money back. There is no MD income whatsoever. When this is refunded, whether I put it on the A or not, they will get a 1099 for the refund.

I'm afraid it will bite me if I do NOT claim the deduction and in turn do NOT claim the income that will, no doubt be on the 1099. I'll have to explain it, is what I am saying. I don't want to "camp out" with this issue next year.

What did you mean by that last line?

~possi

[WD Kebschull]

Don't Claim Taxes Paid on Schedule A

I believe that it is best not to claim a deduction for the tax paid to Maryland when it going to be refunded. Here is why ...

An itemized deduction such as a state income tax is taken "below the line" while the refund of the tax would be added "above the line". As a consequence the deduction can only reduce taxable income dollar for dollar at most while the taxable income attributable to the refund can be more that twice the amount of the refund based on IRS instructions.
For example a state income tax refund of $1000 can result in up to an additional $850 of taxable Social Security benefits, and then the $1850 of AGI can reduce medical miscellaneous, and casualty and theft loss deductions. You might want to compare these consequences of IRS instructions with the language in section 111(a) of the Internal Revenue Code.

The National Taxpayer Advocate's Annual Report for 2006 has a table that lists 24 items that are impacted by Adjusted Gross Income or some variation of Modified Adjusted Gross income. In all cases the the impact of increased AGI or MAGI increases taxes as a result of reducted deductions, credits, exemptions, exclusions or eligibilities. Not listed in the table are medical, miscellaneous, and casualty and theft loss deductions, the mortgage insurance deduction, and the refundable Alternative Minimum Tax Credit.

Additionally, claiming a large tax deduction unrelated to any real income can lead to an AMT liability. If the tax paid to Maryland is claimed as a deduction and produces a limited long-term capital gains rate based benefit (ordinary income below the threshold for 25 percent) by causing more capital gains to be taxed at 5 percent and fewer capital gains to be tax at 15 percent and the AMT is paid, the refund or some portion thereof could be taxed at the regular tax rate in the refund year even though the tax paid to Maryland did not reduce AMTI. See Publication 525 for determining a tax benefit related to a recovery when the AMT was paid. Again compare the consequences of IRS instructions with section 111(a) of the IRC.

Cheers,

WDK

[Possi]

thanks

Thanks for the clear vision of the ripple effect. I really appreciate the depth of your reply.

I will not claim the taxes as itemized deduction.

~possi