I received a form 1099-MISC for the SoCal WaterSmart turf removal program rebate we received 2022. I reported this on my federal tax form and I just received a letter from the IRS asking for more information regarding the rebate and stated it may be subject to Self-Employment Tax for social security and medicare taxes. Can you confirm this is correct? If so, how do I compute this through Turbo Tax once I already completed my taxes?
How exactly did you report it? As taxable "other income"? Was it on a form 1099-MISC or 1099-NEC? And which box number on the 1099?
For background, I would argue the rebate is not taxable at all, but it reduces your cost basis in your home, which will result in a larger capital gains when you sell, but is not immediately taxable. For example, if you spend $10,000 on landscaping, you can increase your cost bases by $10,000. If you get a $4000 rebate, you only increase your basis by $6000, but the rebate is not taxable, even though the city reported it on a 1099.
See update below.
Your general response would be either,
1. Write a letter back explaining the program, that you did not perform work for the money, include copies of the rebate application and other paperwork, and that you have reported it as other taxable income. (Then, note for the future, that if you pay tax on the rebate, you do not have to reduce your home's cost basis by the amount of the rebate.)
2. Write a letter back explaining the program, that you did not perform work for the money, include copies of the rebate application and other paperwork, and state that after taking further tax advice, you believe the money is not taxable at all because it should be reported as a reduction in cost basis of the home. You would also include an amended return removing the 1099 as income, which should result in a refund to you.
If you go with #2, you may want to do some research or hire an accountant to help you write the letter so you can include citations to specific sections of the regulations, IRS letters, or other authorities, that may be difficult for a layperson to find. See update below.
I have found several sites that indicate the rebate is indeed taxable, and I have not found any site that supports my argument about basis. So you would go with answer #1, write a letter and include documents that this was a turf removal rebate, not work or services that you performed, so is it taxable but not "Self-employment." Likely the computer that generated the letter only saw a 1099-MISC and decided to challenge it, and did not look into what it was for.
However, the rebate is NOT taxable on your California return. There is a procedure in Turbotax to include the rebate in your taxable federal income but then subtract it from your state return. If you included the rebate in your state taxable income, you may be able to file an amended state return to remove it and claim a refund.
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