State Tax Refund, 1099-G

[Josh123]

In 2017, I took the itemized deduction and included state refunds/liabilities in the formula. My wife and I lived in VA, but she worked in MD. Taxes were withheld throughout the year in MD, so at the end of the year, I had to essentially get money back from the state of MD and turn around and pay it to VA. This year, MD sent me a 1099-G for the full amount as if it were a refund, with the implication that I owe federal taxes on it. The only advice I can find is to add this amount as taxes paid in Schedule A. That said, with the changes to the tax code, I am no longer itemizing. How can I be sure that I do not pay taxes on this amount?

[NCperson]

would you mind being more specific on the net effect of what you received back from MD and what you owed VA? 

if the net effect was you received a refund from 2017, that means you had too many deductions which you received a federal tax benefit that you really weren't entitled to, so in 2018 it's time to 'settle up' on that situation and pay back the federal tax advantage. It's taxable income.  That is simply the way it works. 

if the net effect was you owed money, you are caught in the new tax law and can only capture the benefit if you itemize. 

but maybe you are going one step further, you owed VA from 2017 and won't be itemizing in 2018 and you got a refund from MD and that is income.  is that the issue? 

[Josh123]

Thank you so much for the quick reply. To provide further clarity:

• The amount paid to VA was slightly less than the amount refunded from MD. I believe what you are saying is the net benefit should be taxable (which makes sense). I did not receive a 1099-G from VA since it was a refund, so how do I properly present such that I am only paying on the net benefit?
• Correct on your second point. I owed money to VA in 2017 (say $3k for example) and I received a "refund" from MD in 2017 in for $5k. I assume my net benefit for purposes of my 2018 return (because I itemized in 2017) should be taxes on the $2k (difference). However, the only tax documentation I have is the $5k refund from MD. If I am electing standard deduction this year, how/where do I account for this? 

[NCperson]

the best I can figure out is the worksheet on page 88 of the attached.  That is the IRS's official determination of figuring out what is taxable

https://www.irs.gov/pub/irs-pdf/i1040gi.pdf

also, please read through the exceptions in the middle of page 86 and see if any apply.  If yes, the go to Publication 525. 

I suspect at a minimum, the net amount ($2000 is taxable which I think you readily agree with) but I would not be surprised if it works out that the entire $5000 is taxable.  One could make the case you are getting the benefit - it's just rolled into the standard deduction.

[Josh123]

Got it - thank you for providing and for the continued support. The worksheet seems to imply that I owe taxes on the full refund, but I do not understand personally. If the goal is to pay taxes to "make up" for overwithholdings at the state level that decreased my federal tax liability in the prior year, it does not make sense for the following year tax liability to be the gross refund amount and not the net refund amount. By paying taxes on the gross amount, it feels like I am being double taxed on the net amount.

For example, if I owed $1mm in taxes in VA and had $1.01mm of taxes withheld in MD, my following year 1099-G would show a tax liability on $1.01mm of income (from MD with nothing received from VA), when in reality the net tax shield I received in the prior year was $0.01mm. Maybe I am missing something, but am having trouble following the logic.

[mpozzi01]

I have the same issue in NY and CT.  My net amount is $9K, so will be out about $3K as a result.  It seems that we're both screwed, unfortunately.  Completely agree that it's total BS.

[dmertz]

Assuming that you itemized in 2017, the state tax payment made to MD would have been included on your 2017 Schedule A.  Because this was refunded in 2018, it becomes taxable income on your 2018 tax return and effectively offsets the deduction that you received on the 2017 tax return.  The result is roughly the same as if the tax payment to MD had never been made.  The only slight difference is that an amount of taxable income equal to the MD tax withholding simply transferred from 2017 to 2018.  Given that the federal tax rates are generally lower for 2018 and the standard deduction is higher, it's likely that this is actually beneficial to you.

If you did not itemize and claim the MD tax withholding on 2017 Schedule A, the MD tax withholding was not deducted on your 2017 tax return and the refund from MD is not taxable on your 2018 tax return.

The same would be true no matter what states are involved.

[mpozzi01]

Here's the issue in my mind, using illustrative #s:

2016 VA tax refund received in 2017: $10,000 (taxable on 2017 return)

2016 MD tax owed in 2017: $4,000 (deductible on 2017 return)

2017 property taxes: $20,000 (no cap on SALT + property tax)

Net amount of $6,000 carried forward and included in 2017 AGI

2017 VA tax refund received in 2018: $12,000 (taxable on 2018 return)

2017 MD tax owed in 2018: $9,000

2018 property taxes: $20,000 ($10,000 cap on SALT + property tax)

All $12,000 taxable in 2018, none of $9,000 tax owed in 2018 for 2017 return deductible, due to $10,000 SALT cap taken up by property tax.  In past, the $9,000 would have been effectively netted from the $12,000 as a deduction.

Seems like the $9,000 should be netted from the $12,000, but doesn't seem like the IRS agrees, at least based on any guidance I have read.

[NCperson]

<< In past, the $9,000 would have been effectively netted from the $12,000 as a deduction.>>

I agree with your assessment

The tax law did change and there is no evidence that the situation you and others have raised was grandfathering in

Hence the deductions are lower than last year or the standard deduction is kicking in