The IRS is denying the deduction on the "Other Income" line because that line is for reporting income (or very specific adjustments), not for claiming state taxes paid. Here is their rationale behind it.
- I assume that your client is taking the position that if they did not itemize in those prior years, when they "elected" to take the Standard Deduction instead of the SDI deduction, they can claim that retroactively this year. That is false.
- To claim them, they must file prior year's amendments to claim those previous SDI state taxes they missed previously. To claim, they will need to:
- File Form 1040-X for those years to switch from the Standard Deduction to Itemized Deductions (if the SDI + other taxes exceeds the Standard Deduction).
- If the Standard Deduction was still higher even with the SDI included, then the SDI tax provides no federal tax benefit.
As far as reference, I like The Timing Rule: IRC Section 461(a).
IRC § 461(a) states:"The amount of any deduction or credit allowed by this subtitle shall be taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income."
If not taken in the year the taxes were paid, the SDI taxes can't be claimed retroactively.
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