tax-exempt interest seems to be copied incorrectly from federal to California return

[skybrian]

On our taxes this year, we entered three 1099-DIV forms with some California tax-exempt interest on them. (For the remaining interest, we entered "Multiple States" as explained in the help.) Later, when working on the California state taxes, it says "Tax exempt interest of $XXXX transferred from your federal return."

However, the number seems incorrect. I think it's supposed to be the sum of all the amounts entered for California in the 1099-DIV's. After checking several times, I'm convinced that either it's a bug in TurboTax, or I fundamentally don't understand what's going on and the formula is something other than a simple sum.

Can anyone explain what's going on here? If not, how do I file a bug?

[MarilynG1]

Were the amounts entered for California on your 1099-DIV all tax-exempt for both your Federal and California returns?

Some federal tax-exempt dividends are not always tax-exempt for state.  State-taxable dividends often come from mutual funds or Exchange Traded Funds (ETFs) that hold a multi-state portfolio of municipal bonds. 

All of the income from those bonds, other than than those issued within your home state, are taxable by your home state.  

Click this link for more info on California Tax Exempt Dividends. 

From the California Form 540 Instructions:

"Certain mutual funds pay “exempt-interest dividends.” If the mutual fund has at least 50% of its assets invested in tax-exempt U.S. obligations and/or in California or its municipal obligations, that amount of dividend is exempt from California tax. The proportion of dividends that are tax‑exempt will be shown on your annual statement or statement issued with federal Form 1099-DIV, Dividends and Distributions."

Since we can't see your tax return in this forum, you can request an Offline Review for a tax expert to review your return.

[skybrian]

Yes, I've learned how the law works. These are all bond funds. One is nearly all California tax-exempt and the other two contain less than 50% California state bonds (the remainder is other states), so an adjustment needs to be made in the state return.

The adjustment at the state level is difficult to make because Turbotax isn't starting out with a number that makes sense. I can separately calculate what it should be and put a number into the form to make it come out right, but it seems like TurboTax isn't doing the right thing.

(This is less about tax law and more about how TurboTax works.)

[drcox]

Hi @skybrian I think I've reverse engineered what's happening here.  Does your 1099-INT also include "bond premium paid on tax-exempt bonds" (box 13 in 2021 forms)?  Or, did you enter an adjustment to the tax-exempt interest for something like accrued interest paid on those bonds?  

Long story but hopefully this helps.  I was similarly confused when Turbotax says it has transferred a seemingly-random amount of "tax exempt interest from CA sources" to my CA return.  It claims it transferred this from Schedule B, but there's no matching number anywhere on Schedule B, and switching into Forms mode doesn't really show where that number came from.

It seems the "transferred" number includes pro-rated amounts for adjustments made on the federal forms.  Seems to be computed as:

[Federal tax-exempt interest from CA bonds] - [(Percentage of interest that's from CA bonds) * [Adjustments entered for bond premiums and accrued interest])

Plus a similar computation for tax-exempt dividends reported on 1099-DIV.  

For the purpose of this example I zero'd out any dividends and focused just on tax-exempt interest.  My situation:

• $15,575 total federally tax-exempt interest reported on 1099-INT from a bunch of municipal fonds
• $11,250 of that interest was from CA municipal bonds
  • I broke this out in the TT interview details for the 1099
  • Thus, the ratio of CA-exempt interest is 11250/15575 =72.23% 
• $11,754 was reported on this 1099-INT for premium paid on tax-exempt bonds.
• $434 manually added by me as an adjustment for accrued interest paid on my bonds at time of purchase

TurboTax transfers to my CA form: $11,250 - 0.7223 * ($11,754 + $434) = $2447  of "tax exempt interest from CA sources".

I also have some "Exempt-interest dividends" from bond funds, reported on a different 1099-DIV in Box11.  But since it's kinda a pain to figure out what % of each of those funds are specifically from CA bonds -- and in general, it's 5% or less -- I just declare those to be from "multiple states" and let CA take their extra $40 or whatever it ends up being.

Net: I think TT is doing the right/intuitive thing to pro-rate adjustments and save me a bit on CA taxes by taking those bond premium and accrued interest costs.  But since they obfuscate this calculation it's just not clear from the forms what they are doing.  It could probably be more precise if I split separate 1099s for CA and non-CA bonds, separating out how much premium and accrued interest mapped to which states.  

But I've got a day job and CA has enough of my money.

[MBR6]

My California return for 2023 is picking up the tax-exempt interest amount form 2022.  I have not reported and tax-exempt interest on my 2023 federal return.  How can I fix this?