State Tax refund with first quarter 2018 estimated tax payment

[cah14522]

I am doing my Dad's taxes, and he has (perhaps) a unique situation.  He received a state tax refund for his 2017 tax return. In addition, he also paid estimated state taxes in the first quarter of 2018, before the deadline, so they were not deductible on his 2017 federal return. How do I determine if the 2017 state tax refund is taxable?  Normally, it would be taxable, since he did itemize deductions in 2017 - but due to the Q4 '17 state estimated taxes not being deducted, how do I calculate the taxable amount of this refund, and how do I claim the estimated taxes paid in early 2018 for tax year 2017?  Thanks in advance.

[Opus 17]

Is the refund more or less than the final estimated payment?

[cah14522]

The refund ($177) was less than the final estimated payment ($800).

[Opus 17]

The refund is not taxable in 2018.  Instead, when you report your itemized deductions for 2018 state taxes paid, reduce your deduction by the amount of the refund.

Explanation: suppose you made 3 payments of $800 in 2017, with a final payment of $800 in 2018, followed by a refund of $177 in 2018.  Your actual state income tax for 2017 was $3023, you paid $2400 of that in 2017, and $623 ($800 - $177) in 2018.  So, $2400 was the correct itemized deduction for taxes paid in 2017 to be reported on your federal return, and the refund is not taxable because.  For your 2018 return, your state income taxes paid are $623 for the 2017 tax season that was paid in 2018, plus whatever you actually paid in 2018 toward the 2018 state taxes owed (estimated payments and withholding.) 

[cah14522]

Thank you for that thorough explanation.  Would it matter if there was also other state taxes withheld and paid during the 2017 year?  So in addition to the $800 estimated taxes paid in per quarter, $2400 of which was taken as an actual deduction in 2017 on Federal form A, there was also state taxes withheld totaling $936 more, plus $212 of state taxes that were paid in 2017 for the 2016 return.  That amounts to a total Schedule A, Line 5 amount of $3548 for his 2017 return.  Thanks again.

[Opus 17]

No, the only issue would be if the taxpayer deducted more taxes than they actually paid to the state (after considering refunds).

To look at it slightly differently.  Suppose you deducted $3000 and got a $200 refund.  That means you paid more than you owed; you deducted too much state tax, and normally you would have to amend the previous return to change the deduction to $2800.  That's a lot of mess to go through, so the alternative procedure is to report the refund as taxable income the next year, using the "tax benefit" rule.  If you get a tax benefit from a deduction, and something changes that would have changed the tax benefit, then you report the income.

In this case, the actual taxes were more than claimed as a deduction, so the refund does not create an overage.  There would be no need to amend the return (if that was the correct procedure) because the actual taxes paid in 2017 are still correct (it doesn't matter that some were for 2017 and some were for 2016, the taxes paid in 2017 were all monies that were actually owed in 2017.)  The refund in 2018 doesn't change the tax benefit of the amount taken as a deduction in 2017, so it's not taxable now.  It does reduce the amount you can claim as 2017 taxes paid in 2018, of course.  

[cah14522]

OK - that makes sense.  But now what about if he doesn't end up itemizing this year, because the standard deduction is higher under the new tax code?  In that case, I won't be able to reduce the $800 paid in 1Q18 by the $177 refund received in April of 2018.  Does that change the answer at all?  And how do I document all of this on his return, which I will be filing electronically?  Thanks again for all your help and direction.

[Opus 17]

It doesn't change anything if he can't itemize this year.  The point is, this $177 does not represent a taxable recovery of an amount previously deducted on the 2017 return, because it represents a recovery or rebate or refund of an amount  paid a couple months earlier in 2018.

You deal with 2018 on its own, if you don't deduct any state tax, then you don't deduct the final 2017 payment and you don't have to adjust it.

There is no place to "show your work" for this.  Keep records, and if the IRS sends a letter asking if the $177 should have been taxable, you reply as we discussed here.

[NCperson]

a lot of good dialog , but isn't it rather simple? 

It's cash basis accounting so whatever was PAID in 2018 is deductible if you itemize - whether that money is for 2018 or 2017 taxes the fact is it was paid in 2018

the refund from 2017 is taxable income in 2018  only if you itemize in 2018

please correct me if I am wrong,   

[Opus 17]

@NCperson sorry, but you have it wrong.

Money received in 2018 might or might not be taxable income in 2018 -- that's the cash basis rule.  But in the case of a reimbursed deduction, you have to look at the tax benefit rule.   This says that for a previous deduction that is reimbursed or recovered, the taxable amount depends on the tax benefit that originally obtained from the deduction.

Some examples.

1. If you receive a state tax refund in 2018, but used the standard deduction in 2017, then the refund is not taxable income in 2018, because you got no tax benefit from claiming a deduction in 2017.  It doesn't matter whether or not you are itemizing in 2018, it depends on whether you originally got a tax benefit from the deduction.

2. A few years ago, there was a class action settlement between mortgage lenders and the US govt over excess interest charged to active duty service members in violation of a particular law designed to protect service persons from losing their homes.  The service persons received interest rebates.  Whether that income is taxable in the year the rebate was paid, requires analyzing all the past tax returns for the years covered by the rebate, to determine, for each particular year, did the taxpayer deduct their interest and if so, did it lower their income taxes.  Depending on the particular taxpayer, the interest rebate might have been fully, partly, or not at all taxable income.

3. Suppose I paid $4000 in state withholding in 2017 and claimed it as an itemized deduction.  My total itemized deductions were $7,000.  I get a $1000 state refund in 2018.  Only $600 of the refund is taxable.  That's because, if I had only tried to deduct $3000 of state income tax, my itemized deductions would be $6000 but the standard deduction was $6400.  So the tax benefit in 2017 of the now-refunded money was $600, so $600 is taxable in 2018.

There can be many other examples.  A vendor who gives a rebate in 2018 to a schedule C sole prop for materials purchased in 2017.  Property tax refunds.  A charity returns a donation for some reason.  

See this IRS document for how the tax benefit rule might apply to 2019 tax returns where there is a refund of state tax after the imposition of the $10,000 cap.  The tax benefit rule is not new, although these particular scenarios are new.  https://www.irs.gov/pub/irs-drop/rr-19-11.pdf

In this particular case, the refund is not a refund of an amount deducted on the 2017 return, it is a refund of an amount paid a few months earlier in 2018.  So it does not represent a refund of a tax benefit from the 2017 return.  Instead, it reduces the net amount of state income tax that can be listed as a deduction on the 2018 return, assuming the taxpayer itemizes their deductions in 2018.

[Gary25]

This is not a REFUND, IT'S A ESTIMATED PAYMENT FOR THE NEXT YEAR (i.e 1/15/2020).

[DaveF1006]

To report your state estimated taxes for each year, do the following:

1)  Go to federal>deductions and credits>Select see all tax breaks

2)  Select Estimates and Other Taxes Paid>select Show more

3)  Go to Estimated Tax Payments Select Start

4) Select State estimated taxes for 20...  You need to do this for each year you paid the state estimated taxes..