ATTENTION DUAL INCOME MARRIED NEW JERSEY TAXPAYERS ON EXTENSION

 

Have you filed your 2021 tax returns yet?  If not (this does not work on an amended return) before doing so you should purchase and read my special report AVOID NEW JERSEY TAXES LEGALLY to find out how to save from hundreds of dollars to thousands of dollars in NJ state income tax (and maybe some federal tax as well), depending on the extent and source of your individual incomes.

This report includes several historical real-life examples from my tax practice (I have been preparing NJ-1040s for as long as there has been a NJ-1040 and recently retired after completing 50 tax seasons) of how I used a special strategy and loophole to save my clients hundreds to thousands of dollars in NJ state income tax and a special worksheet to use to calculate your tax savings.

It also briefly discusses other ways to legally avoid NJ state income taxes.  

I will send you this special report for $6.99 plus $1.80 postage and mailing – a total of only $8.79.

Send your check or money order (payable to TAXES AND ACCOUNTING, INC) for $8.79 and your postal mailing address to –

AVOID NJ TAXES LEGALLY
TAXES AND ACCOUNTING INC
POST OFFICE BOX A
HAWLEY PA 18428 

TTFN

LEARN HOW TO AVOID NEW JERSEY TAXES LEGALLY

As I say at the beginning of a new special report I have just completed – AVOID NEW JERSEY TAXES LEGALLY – “I have been preparing NJ-1040s for as long as there has been a NJ-1040.”

This new report explains in detail a tax strategy a NJ married couple can use to legally save up to $300+ in NJ state income taxes.  And perhaps save some federal income tax as well.

And it also identifies a special, I expect unintended, loophole in NJ state tax law that older married couples can use of to save as much as $2,500 in state income taxes.

The people who enact federal and state tax law – the members of Congress and state legislatures – have absolutely no concept of the practical application of the tax laws they pass.  In most cases they do not even read the legislation – they just do what the Party leadership tells them to do.  In this report I show you how to take advantage of the ignorance and laziness of the NJ legislature to put hundreds or thousands of dollars in your pocket.

This report includes several real-life examples of how I used this strategy and loophole to save my clients hundreds to thousands of dollars in NJ state income tax over the past few years and a special worksheet for your personal use.  It also briefly discusses other ways to legally avoid NJ state income taxes.

If you have not yet filed your 2021 NJ-1040 – you have requested an extension – you can use this strategy and loophole to reduce your 2021 state tax liability.  If you have already filed your 2021 return you can use this report to save for 2022 and beyond.

I will send you this special report for $6.99 plus $1.80 postage and mailing – a total of only $8.79.

Send your check or money order (payable to TAXES AND ACCOUNTING, INC) for $8.79 and your postal mailing address to –

AVOID NJ TAXES LEGALLY

TAXES AND ACCOUNTING INC
POST OFFICE BOX A
HAWLEY PA 18428

TTFN

FINALLY!

  

The 2021 New York State income tax returns, forms, schedules, and instructions are finally available to download online on the website of the New York Department of Taxation and Finance.  Click here.

A brief review of the 2021 IT-201(resident) and IT-203 (non-resident and part-year resident) returns indicates they are exactly the same as the 2020 forms – no changes to the descriptions and line numbers on either form.

The instruction booklet for both forms do not have a page to identify “What’s New” for 2021 returns as they usually did in the past – but a NY state tax update I “attended” in January (part of an online webinar) discussed the following changes of note –

* New York now has a PTET (Pass Through Entity Tax), which is the Empire State’s version of NJ’s BAIT tax scam, to assist NY taxpayers in evading federal income tax.

* New York continues to decouple from federal tax law changes.  It currently does not follow the temporary or permanent federal changes to the Earned Income Tax Credit (EITC).

* There is a new NY Real Property Relief Credit of between $250 and $350 that is calculated on NY Form IT-229.  The NY itemized deduction for property tax paid that is claimed on IT-196 is reduced by the amount of the credit claimed on IT-229.

And while we are on the subject of state taxes, the Pennsylvania 2021 state income tax returns, forms, schedules, and instructions are also now available online.  Nothing of any consequence new for PA state returns either.  Click here.

TTFN

NJ, NY AND PA FOLLOW IRS FILING DEADLINE EXTENSION

NJ.COM reports “N.J. extends tax deadline to May 17, matching federal change” –

“But there will not be an extension for first quarter 2021 individual estimated tax payments, the statement said. Those will still be due on April 15.”

I have not seen anything on the NJ Division of Taxation webpage yet.

As For New York, according to N-21-1 –

“The Commissioner of the New York State Department of Taxation and Finance has extended the due date for personal income tax returns, and related payments, for the 2020 tax year from April 15, 2021 to May 17, 2021.” 

But, as with the IRS – 

“This relief does not apply to estimated tax payments for the 2021 tax year that are due on April 15, 2021. These payments are still due on April 15, 2021.” 

And from the Pennsylvania Department of Revenue –

“The Department of Revenue today announced the deadline for taxpayers to file their 2020 Pennsylvania personal income tax returns and make final 2020 income tax payments is extended to May 17, 2021.”

And -  

“Those who make estimated income tax payments should continue to do so on the same filing schedule that they would normally follow. This includes taxpayers with estimated tax payments due on April 15, 2021.” 

Not from New Jersey, New York or Pennsylvania.  You should check the website of your state tax agency to see if it has extended the filing and paying deadline.

TTFN

“BAIT” AND SWITCH

I am trying to understand the legitimacy of the new “NJ BAIT”.

 

As explained on the “Business Alternative Income Tax” (BAIT) FAQ page of the NJ Division of Taxation website –

 

“For New Jersey tax purposes, income and losses of a pass-through entity are passed through to its members. However, for taxable years beginning on or after January 1, 2020, pass-through entities may elect to pay a Pass-Through Business Alternative Income Tax due on the sum of each of the member’s share of distributive proceeds. The member(s) may then claim a tax credit for the amount of tax paid by the pass-through entity on their share of distributive proceeds.”

 

The website of an accounting firm I found in a search tells us –

 

“The significance of this election is that the business taxes paid by an eligible entity can be deducted in determining federal income that passes-through to the owners, resulting in less federal tax paid by the owners on their share of the PTE income.”  

 

I assume the entity’s BAIT payment is claimed as a state income tax deduction on the federal Form 1065 or 1120-S, reducing the net taxable income passed-through to the partner or shareholder.

 

But what is actually happening?  The pass-through entity is making a payment of state income tax, calculated on the income of the entity, on behalf of the partner or shareholder.  The income of the entity, before any deduction for the BAIT, is still passed-through to the individual partners or shareholders on the NJK-1 and reported on Line 21 or 22 of the NJ-1040.  The partners’ or shareholders’ individual NJGIT liability is calculated based on this income. 

 

The BAIT payment allocated to the partner or shareholder is in effect an estimated tax payment of NJGIT.  If the actual tax cost of the pass-through income is more than the BAIT payment the partner or shareholder pays the additional tax.  If the tax cost is less than the allocated BAIT payment the partner or shareholder gets a refund or reduces the balance due.  

 

The BAIT payment made by the entity is not an expense of the entity but a payment made on behalf of the partner or shareholder.  It is not an expense of the entity, but a distribution of partner capital or shareholder PTI made to the State of New Jersey.

 

It appears to me that this is just a scam to allow New Jersey taxpayers to legally cheat on their federal income tax return.  The GOP Tax Act limited the itemized deduction for State and Local Taxes (SALT) to $10,000.  The BAIT is a way to “work around” this limitation so taxpayers could deduct a portion of their NJ state income tax, calculated on their NJ state individual income tax return, somewhere else on the federal return.

 

I certainly understand what New Jersey is trying to do.  I personally oppose the SALT limit – but for a unique reason (see my post “Defending the Deductions for Taxes and Mortgage Interest”).   But what about “substance over form”?  You can call it a “credit” and not an estimated tax payment, but if it walks like a duck  . . .

 

To be an actual legitimate entity-level state income tax should not the election be to pay BAIT on the entity’s net taxable income in lieu of passing the entity’s income to its partners or shareholders?  The entity would elect to not pass through its income to partners or shareholders.  An entity electing BAIT would not issue a NJK-1 to its partners or shareholders, and the partners or shareholders would not report any income from the entity on Form NJ-1040 Lines 21 or 22.  Since the individual partner or shareholder is not paying NJGIT on the income of the entity there would be no BAIT credit on the NJ-1040.   

 

So, what do you think?

TTFN

WHAT’S NEW FOR THE 2020 NEW JERSEY STATE TAX RETURN

 

There are very few changes to the 2020 NJ-1040.  There are three (3) new lines, and other lines have been somewhat revised so that the 2020 return has a total of 78 lines instead of 76.

The three new lines are –

Line 36 – to enter the Organ/Bone Marrow Donation Deduction.  NJ taxpayers who donated organs or bone marrow in 2020 can deduct up to $10,000 in unreimbursed “out-of-pocket” expenses for related travel, lodging, and lost wages.

Line 48 – to enter a “Credit for Employer of Organ/Bone Marrow Donor” for self-employed employers who provided paid time off to an employee who missed work to donate an organ or bone marrow.

Line 63 – to enter the new “Pass-Through Business Alternative Income Tax Credit”.  The amount to be reported here is taken from a new Schedule PTE-K-1 provided by a pass-through entity – i.e. a partnership or a sub-S corporation – or a Schedule K-1 provided by an estate or trust.

As per new tax law –

1) The final phase-in of the increased Pension and Other Retirement Income Exclusion takes effect - the maximum deduction is $75,00 for Single or Head of Household, $100,000 for Married/CU Couple Filing Joint Return, and $50,000 for Married/CU Couple Filing Separate Return.  Unfortunately, the “Total Income” (NJ-1040 Line 27) limitation remains $100,000 – so as little of $1.00 in additional income can cause a NJ taxpayer to pay hundreds or more in NJ state income tax.

2) The 2020 NJ Earned Income Tax Credit (EITC) is increased to 40% of the 2020 federal credit.  And NJ residents who were not eligible for a federal EITC are eligible for an NJ EITC of $215 if they met the following requirements during 2020 -

· did not have a qualifying child; and

· were age 21 to 24 on the last day of the tax year; and

· met all federal EIC requirements except the minimum age requirement. 

3) The 2020 maximum employee contributions to the unemployment, disability and family leave programs, used to calculate any excess contributions based on more than one employer on Form NJ-2450, are much higher than in past years –

Unemployment = $150.03

Disability = $350.74

Family Leave = $215.84 

4) A new tax rate of 10.75% applies to net taxable income over $1 million. 

Go here to download 2020 NJ state individual income tax forms, schedules and instructions.

TTFN

WHAT’S NEW FOR 2019 NEW YORK STATE INCOME TAX FORMS

Yesterday (Monday) New York State finally released the 2019 Form IT-201 and 2019 Form IT-203.  These forms are now available online at the NY Department of Taxation and Finance website, and online filing and “enhanced” fill-in forms is also available. 

There appear to be no changes to the format or layout of the 2019 forms.  They look exactly the same as the 2018 forms.  The few minor changes to NYS individual income taxes are -

* A few new obscure credits have been added and some expired ones have been extended.

* There are now so many voluntary contribution options on the IT-201 and IT-203 that New York has created a new Form IT-227 to claim voluntary contributions, with a total amount carried over to the IT-201 or IT-203.

* NY had originally “decoupled” from the new increased 60% of AGI limitation on the federal itemized deduction for cash (or check) contributions, keeping the previous 50% of AGI limit.  The state has changed its mind and has retroactively “recoupled” with this GOP Tax Act change – accepting the increased 60% deduction limit for 2018, 2019 and subsequent returns (until 2025). 

Speaking of “decoupling” - a reminder that NYS has “decoupled” from most of the Form 1040 changes enacted by the GOP Tax Act - 

* On NYS resident or non-resident income tax returns alimony continues to be included in income or allowed as a “adjustment to income” deduction, regardless of when the decree or agreement is dated, and there are new addition and subtraction modifications to be entered on the IT-201 and IT-203 to report or deduct alimony not reported on the 2019 federal Form 1040.  These modification codes are A-119 to report taxable alimony income and S-136 to deduct alimony paid.

* And NY continues to allow you to itemize on your NY State IT-201 and IT-203 regardless of whether you itemized deductions or claimed the Standard Deduction on your federal Form 1040. Like last year, New York Itemized Deductions are computed using the “old” federal rules as they existed prior to the enactment of the GOP Tax Act.  The deduction for property taxes is not limited to $10,000, and home equity interest on up to $100,000 in principal, all casualty and theft losses, and all previously allowed Miscellaneous expenses, including investment expenses and unreimbursed employee business expenses, are deductible on the NY return.  So, if you will be filing a NY state income tax return for 2019, your tax preparer will need information on all these deductions. 

TTFN

IF AT FIRST YOU DON’T SUCCEED TRY, TRY AGAIN

On January 13, 2020, NJ Governor Murphy signed into law “The Pass-Through Business Alternative Income Tax Act”.  This act allows NJ “pass-through” businesses such as partnerships, sub-S corporations and sole proprietorships to elect to pay an entity-level alternative tax and provide partners, shareholders and the proprietor with a tax credit on the NJ-1040.

The new alternative tax election is effective for taxable years of the pass-through entities beginning on or after January 1, 2020.  This does not affect 2019 tax returns.

This is clearly another attempt by NJ to work around the federal $10,000 state and local tax (SALT) itemized deduction limitation enacted by the GOP Tax Act by changing a (perhaps) non-deductible individual income tax into a (hopefully) deductible state business income tax.    

The first attempt failed.  In May of 2018 Murphy signed legislation that would allow a taxpayer to donate to a charitable fund established by their municipality, county or school district. In return for their donation, the taxpayer would receive a credit on their property tax bill of up to 90 percent of the donation.  The assumption was the taxpayer could deduct the full amount of the donation as a charitable contribution on Schedule A, effectively providing a back-door deduction for the property tax.  The IRS was quick to point out that any deduction for a contribution to such a charitable fund must be reduced by the amount of the property tax credit received under the federal Trump (new synonym for “quid pro quo”) rule.  Only 10% of the donation is allowed as an itemized deduction.

I am not sure what the practical implementation of this new law on NJ tax returns will look like.  While NJ partnerships and S-corporations already file a tax form on which they can elect to pay the tax, will sole proprietors who file a federal Schedule C now have to file a new separate NJ business tax return to pay the tax? 

From what I have found in an initial online search the tax the pass-through entity will pay is -

1) 5.525% tax on the first $250,000 of distributive proceeds  

2) 6.37% tax on distributive proceeds between $250,000 and $1M  
3) 8.97% tax on distributive proceeds between $1M and $3M
4) 10.75% tax on distributive proceeds over $3M.

The above tax rates mirror the higher end of the current NJ tax rates for Form NJ-1040. 

I will be interested to see how the IRS responds to this new attempt to help NJ taxpayers evade federal income tax.  It is clear what NJ is doing, and the Service will certainly understand this.  I would think in order for this scheme to work NJ would have to make the entity-level tax mandatory and not optional and exempt from taxation on the NJ-1040 the pass-through income from NJ-based partnerships, sub-S corporations and net profits from business (federal Schedule C).

I will certainly to have more to say about this new tax scheme after the tax filing season when more information becomes available.

TTFN

THE NJ-NATP ANNUAL “FAMOUS” STATE TAX SEMINAR

Every year at this time you will find me where I have been, with 1 or 2 exceptions for snow, for almost 30 years now – attending the New Jersey chapter of the National Association of Tax Professionals annual “Famous State Tax Seminar”, at the APA Hotel Woodbridge (formerly the Woodbridge Hilton) in Iselin NJ for probably 20 years now.  It truly is “famous”.  As I say each year, it is a “must-attend” for anyone who prepares New Jersey taxes for individuals and businesses. 

As has been the custom each year, the first presentation of the day, after preliminary remarks by the NJ-NATP President and Seminar Chair, is the “keynote” speaker, which is normally the current Director, or Acting Director, of the NJ Division of Taxation.   Unfortunately, while I do believe the NJDOT Director should be invited to speak each year, and his attendance shows his and the Division’s support of, and highlights the importance to the Division of, NJ-NATP and NJ tax professionals in general, the actual presentation usually provides the least amount of actual “continuing professional education”.

This year (still) Acting Director John Ficara returned.  And his presentation was, like last year’s, “redundant, touching briefly on topics that were discussed in more detail by the other NJDOT representatives in subsequent presentations.”

And, as I first observed a few years ago, “ . . . there was really nothing of consequence to ‘take away’.  There was no time for audience questions or comments, and he did not address real systemic issues with the Division.”

I once again repeat my suggestion first made a couple of years ago –  “Perhaps for the future seminars registrants could be asked to submit to the chapter in advance written systemic questions and concerns for the seminar chair to present to the Director instead of the nice but mostly useless keynote address.”

Before I continue, as a point of information, at this point in my career my interest is pretty much limited to individual income tax issues – involving the NJ-1040 and New York’s IT-201 and IT-203 – and only issues that would affect my current clients, although I still have a basic interest in major NJ corporate tax changes and the NJ property tax relief programs.  And, since I no longer accept new clients and am actually winding down toward retirement, as I have said often here and elsewhere, while I do believe you can teach an old dog new tricks, there are some new tricks this old dog doesn’t want to learn, and I say to any existing client to whom these “new tricks” might apply “Homey don’t play that”.

The reason we come to this seminar each year is to learn what is new with NJ state taxes – individual and corporate income, payroll, sales, estate and inheritance, and property.  And the “main event”, so to speak, is always what began in the mid-2000s as the “Jake and Jim Show” (long-time readers of TWTP and long-time attendees of this seminar will know what I mean) and has now become the “Alexis and Abra Show”.  I am talking about the presentations of what is now known as the NJ Division of Taxation’s “Taxation University”.

The TU program started off with sales tax.  As there was apparently nothing new in this area to report the NJDOT representatives walked us through the process and procedures of a sales tax audit.  Not a topic I was interested in.

The individual and property tax relief issues were covered by the Alexis of “Alexis and Abra”, who has been speaking at this seminar for years now and has been extremely helpful to me and other NJNATP taxpros in dealing with NJ tax issues during the year.  Her presentation identified the changes I have previously blogged about here in my post “WHAT’S NEW FOR 2019 NEW JERSEY STATE TAX FORMS” from last Tuesday. 

One item Alexis discussed involved the new sales tax and occupancy tax rules for transient vacation rentals that took effect with 2018.  Effective 8/9/2019, only properties rented via agencies like Air BnB and VRBO, travel agencies like Expedia, or that are “professionally managed” are subject to these taxes.  Individual property owners who personally rent out vacation homes do not have to register with NJ and be concerned with sales or occupancy tax.  And if an individual rents a property via Air BnB, VRBO or another such agency it is the agency that is responsible for registering with the state and collecting and remitting the tax.

Alexis also reported that beginning with 2020, all NJ W-3s, W-2s, W-2Gs, and 1099s - 2020 forms that will be filed in January of 2021 - need to be filed electronically –.  It is anticipated that these forms will be able to be filed directly via a free online option.

There were no changes to either the NJ Homestead Benefit or NJ Property Tax Reimbursement programs, other than increasing the PTR income eligibility limit to $91,505 for 2019.  The filing deadline for the 2019 PTR-1 or PTR-2 form is November 2, 2020.  Alexis reminded us that the 2018 PTR was the first time in over a decade the NJ legislature did not reduce the income limit for receiving a check to $70,000 in order to balance the budget.  All qualified applicants whose PTR gross income was less than $89,014 received a reimbursement check in 2019.  Let us hope the 2019 threshold will remain intact when the budget is passed this June.

There were also no changes to the NJ inheritance tax for 2019 or going forward, but TU did provide present a primer on the rules and policies for this tax - another topic I was not interested in.

As an aside, it is my belief that this day-long seminar should be limited to discussions of changes that affect the current tax filing season and really should not include purely educational presentations.

Abra of “Alexis and Abra” discussed NJ corporate taxes.  Here the major change involved “Unitary Combined Reporting” for corporations with direct or indirect common ownership.  I learned, thankfully, that this will not affect any of my very few remaining corporate return clients (an example of a “new trick” I don’t have to learn).  This blog if about individual income taxes anyway, so I won’t go into this topic here.

The last TU speaker covered “Identity Theft and Fraud Protection” items.  While not really an update, because of the increase in such theft and fraud it is a topic that needed to be addressed.

As has been the custom the last several years, the seminar ended with long-time NATP instructor and friend of NJ-NATP Kathryn Keane’s presentation of NY state tax updates and “Late Breaking Federal Updates”.  There was really nothing new for NY (I will address any changes to the NY state income tax forms in a post here when the 2019 forms are made available online) , so the “meat” of her discussion involved the last-minute extension of the infamous “tax extenders” by the idiots in Congress and the changes to retirement savings from the SECURE Act.

As always, NJ-NATP, the Taxation University, and KK did a great job.  Seminar Chairs Josh Melum and Alyce Taylor and new chapter President Teresa Marron deserve kudos.

TTFN

WHAT’S NEW FOR 2019 NEW JERSEY STATE TAX FORMS

I was truly surprised to find that the 2019 New Jersey state income tax forms,schedules and instructions were up and available at the NJ Division of Taxation website last Friday afternoon.  I seem to recall that the Division was late in releasing the 2018 forms, schedules and instructions.

Last year the forms, schedules and instructions were re-designed and rewritten – for the better.  The 2019 versions appear to be almost the same as the 2018 versions, with some minor changes.

On Line 9 of the NJ-1040 the amount of the Veteran’s Exemption amount has been changed from $3,000 to $6,000 to reflect the doubling of the credit for 2019.

Two lines have been added to the NJ-1040 -

* Line 38d = Homeowner/Tenant Status.  Fill in the oval indicating whether you were a homeowner, tenant, or both during 2019.

* Line 52 = Shared Responsibility Payment.  This replaces the question about health insurance coverage that had appeared above the signature section on Page 4 of the 2018 NJ-1040.

A new schedule - Schedule NJ-HCC: Health Care Coverage - has been added for taxpayers to provide healthcare coverage information.  While you are no longer penalized on the federal return for not having “adequate” health insurance for your entire household for the entire year, NJ has added a “Shared Responsibility Payment” penalty for 2019.  We are told – “If your income on line 29 is above the filing threshold, you must submit this schedule with your return.”  However, if you and everyone in your tax household had minimum essential health coverage for the entire year you only have to complete Part 1 of Schedule NJ-HCC.

The NJDOT website explains (highlights are mine) –

“Beginning in 2019, New Jersey residents who are required to file a return (and members of their tax household) must have minimum essential health coverage for the entire year unless they qualify for an exemption {click here to see the exemptions – rdf}. A tax household includes the taxpayer, their spouse (if filing a joint return), and any individuals they claim as dependents on their NJ-1040. It also includes any individuals they can, but don’t, claim as dependents on their return. If a taxpayer or anyone in their tax household did not have the required coverage and does not qualify for an exemption, they may owe a shared responsibility payment.”

FYI – the Retirement Income Exclusion for 2019 is $60,000 for Single, Head of Household and Qualifying Widow(er/Surviving CU Partner filers, $80,000 for a married couple filing a joint return, and $40,000 for married taxpayers filing separate returns.  The income threshold for claiming this exclusion remains at $100,000.  And the NJ Earned Income Tax Credit is increased to 39% of the federal EITC.

TTFN

JUST IN TIME!

Just in time for Black Friday shopping, and year-end tax planning, I have updated my THE JOY OF AVOIDING NEW JERSEY TAXES, the only book available that I know of that discusses in details NJ state income taxes, for tax year 2019.

A new section on Tax Benefits for Veterans and their Caregivers has been added.

Most NJ taxpayers concentrate on their federal tax return and spend minimal time on their NJ return, simply taking numbers from the 1040 and putting them on the NJ-1040.  As a result, they are paying more NJ state tax than necessary, often paying tax on income that is not even taxed by NJ.  By becoming informed on NJ state tax law and using proper tax planning you can make sure that you pay the absolute least amount of NJ Gross Income Tax possible for your particular situation.

Whether or not you use a professional tax preparer, the more you know about NJ taxes the more you will be able to properly structure your financial transactions during the year to minimize taxes and the better prepared you will be when giving your “stuff” to your preparer at tax time.

I will send you this valuable book as a pdf email attachment for only 11.95.  The cost of a print version, sent via postal mail, is $15.45.

The e-book version for Kindle available from Amazon should be updated by Cyber Monday (December 2^nd) – wait till then to order.  This version does not include the forms, schedules and worksheets included in the versions ordered directly from me.

To order send your check or money order payable to TAXES AND ACCOUNTING, INC to –

TAXES AND ACCOUNTING, INC

THE JOY OF AVOIDING NJ TAXES

POST OFFICE BOX A

HAWLEY PA 18428

TTFN

IS MY STATE TAX REFUND TAXABLE?

Taxpayers who itemize and receive a “tax benefit” from a specific deduction must report as taxable income any refund of the payment deducted you receive in a subsequent year to the extent that the refund provided a tax benefit on the previous return. 

This most frequently occurs when a taxpayer deducted the full amount of state income tax withheld in, for example, 2017 on their 2017 Schedule A and received a refund of some of the tax withheld in 2018.

What is a tax benefit? 

* You are married filing a joint return.  Your total allowed itemized deductions for 2017 was $15,000.  The Standard Deduction for a married couple filing jointly in 2017 was $12,700.  Your itemized deductions exceeded your Standard Deduction by $2,300 – so the tax benefit you received from itemizing for 2017 was $2,300.

* You deducted $3,000 for state income tax withheld on your 2017 Form 1040.  When you prepared your 2017 NJ-1040 you calculated you overpaid your state income taxes by $975.  In 2018 you received a check from NJ for $975.

* The $975 refund from NJ is less than the $2,300 overall tax benefit you received from itemizing.  If you had deducted the correct amount of your 2017 state tax liability, you would have only claimed $2,025 in state income tax and your total allowed itemized deduction for 2017 would have been $12,975.  This is still more than the $12,700 Standard Deduction. 

* You clearly received a tax benefit for the full amount of the $975 state income tax refund.  You must report as taxable income on your 2018 Form 1040 the $975 state tax refund.

States will issue a Form 1099-G for all state income tax refunds issued to a taxpayer during the calendar year.  Unfortunately, most, if not all, states, in an attempt to save money, do not mail this form to taxpayers.  Taxpayers MUST go online to the state tax department website to download and print their Form 1099-G. 

Just because the state issues you a Form 1099-G does not mean that any or all of the amount reported on that form is taxable income.  You only need to report a state income tax refund if –

1) you itemized deductions on Schedule A of the Form 1040 for the year to which the refund applies,

2) you did not deduct state and local sales tax on the applicable Schedule A instead of state and local income tax,

3) you deducted the total amount of state income tax withheld for the year on the applicable Schedule A, and

4) you were not subject to the dreaded Alternative Minimum Tax (AMT) for the applicable year (taxes of any kind, including state and local income tax, is not deductible in calculating the AMT – so you would have received no tax benefit from the deduction of state and local income tax, depending on the amount of AMT and the amount of the state income tax deduction).

The amount of the state income tax refund that is taxable is also limited to the amount that your Schedule A deduction for all state and local income taxes exceeds the amount of state and local sales tax you could have deducted.

You deducted $3,000 for state and local income tax withheld and $200 for state unemployment, disability or family leave taxes withheld (considered to be state and local income taxes for Schedule A purposes).  You could have deducted a total of $2,800 in state and local sales taxes (due to a used car purchase) instead – but that was less than $3,200.  So, you only received a tax benefit of $400 from the deduction for state income taxes.  The portion of the $975 state tax refund that must be included in taxable income for 2018 is only $400. 

This rule still exists.  However, the changes made by the GOP Tax Act substantially eliminated the need to claim state tax refunds as taxable income.  Most taxpayers who had consistently itemized in the past are no longer able to itemize.  And even if you can itemize, the deduction for all state and local taxes (state income taxes or state sales taxes, state and local personal property taxes and local property taxes combined) is limited to $10,000.

Let’s say you were able to itemize for 2018, your total property taxes for 2018 were $9,500, the total amount of state income tax withheld for 2018 was $3,200, and your actual 2018 state tax liability on your 2018 state income tax return was $2,300.  You could deduct only $10,000 in state and local (SALT) taxes on your 2018 Schedule A.  

Whether you claimed the $3,200 withheld or the $2,300 actual liability for state income taxes your 2018 itemized deduction for taxes would be only $10,000.  So, you received absolutely no tax deduction, or tax benefit, for the $900 excess withholding if you claimed the full $3,200.   No tax benefit – no taxable income.  None of the $900 in state income tax refund reported on your 2019 Form 1099G is taxable income - none of the $900 has to be reported on your 2019 Form 1040.

The $10,000 deduction is treated by the IRS as $9,500 in property taxes and $500 in state income taxes.  This has been verified by Internal Revenue Service Revenue Ruling 2019-11.

Taxpayers who were required to claim state income tax refunds as taxable income on their 2018 Form 1040 actually received a fortuitous tax savings as a result of the reduction in tax rates enacted by the GOP Tax Act.

In the original example of a tax benefit at the beginning of this post I showed that the taxpayers had to report $975 as taxable income on their 2018 Form 1040.  Let’s say their federal marginal tax rate for 2018 was 25% but was 22% for 2018.  When they filed their 2017 return the $975 deduction reduced their tax liability by $244 ($975 x 25%).  But the $975 in income reported in 2018 only cost them $215 in federal income tax ($975 x 22%).  So, the bottom line is that they actually saved $29 ($244 less $215).

Hey, better in the pocket of the taxpayer!

TTFN