TurboTax enters adjustment on California return for Treasury interest on wrong line

[CelBar]

Just a note, before I explain the issue. I have done my taxes by hand, reading the IRS booklets my entire life (for many decades now). So I am very familiar with the actual IRS and California state rules, regarding certain things. This year is the first time I'm using TurboTax, in order to help my mother do her taxes (her accountant retired). I thought it might make things easier for various reason.

My mother has a small amount of income from U.S. Treasuries. On the California schedule 540-CA, for making adjustments for differences between taxable income for federal purposes and for state purposes, one enters the amount earned on U.S. Treasuries and other Federal debt obligations in column B (subtractions) in order to reduce one's state taxable income, by the appropriate amount.

The California instructions clearly state that this amount is treated as tax exempt interest and should be entered on line 2, column B, of schedule 540-CA.

Page 58 of the California 540 Forms & Instructions booklet (2023):

"Line 2 – Taxable Interest
If you did not receive any of the kinds of income listed (within this line
instructions), make no entry on this line in either column B or column C.
Enter in column B the interest you received from:
• U.S. savings bonds (except for interest from series EE U.S. savings
bonds issued after 1989 that qualified for the Education Savings Bond
Program exclusion).
• U.S. Treasury bills, notes, and bonds.
• Any other bonds or obligations of the United States and its ­territories."

However, TurboTax enters the amount of taxable interest on line 3, column B instead. This is an understandable mistake, because line 3 is for dividends (as opposed to interest) and the 1099-DIV one normally receives reporting earnings on Treasuries reports those earnings as dividends. But the California booklet clearly states the only place to enter earnings from U.S. Treasuries is on line 2, regarding interest.

Confusingly, if you look at the interest and dividend adjustment worksheet, which TurboTax produces for working these things out, before entering them on the actual California tax forms, TurboTax has two separate places that address interest/dividends on Treasuries. Line 1 in the section Interest Income Adjustments, labeled: "Bonds or obligations of the United States or any of its territories." And then in the Dividend Income Adjustments section a mini worksheet for "U.S. obligations exempt-interest dividends." Turbotax ignores the first section regarding U.S. obligations and uses the second one, which ends up entering the adjustment on the wrong line of the California form, as I explain above. (Also the phrase "exempt-interest dividends" doesn't really make sense, since interest and dividends are two separate things for the purpose of the form in question.)

In the end, this mistake doesn't really make a difference in the adjustment that needs to be made to one's income and the tax consequences. But it is wrong. And the California instruction booklet is so plain and clear on this matter, it's not confidence inspiring to see TurboTax make this mistake.

If I'm missing something, I'd be happy to be corrected. But I've dealt with this for so many decades and puzzled over why California treats earnings on Treasuries as interest, rather than dividends. And the California booklet is quite plain in its directions. So what's worrying me is that it seems like the people who designed TurboTax did not read the California booklet correctly. In which case, what else have they missed?

[MonikaK1]

Is the US Government Interest such as from a bond, e.g., a Series EE Savings Bond and it was reported by the financial institution as Dividends? This is not uncommon. If so, follow these steps to enter the information:

• Enter your Form 1099-DIV exactly as the boxes appear in the 1099-DIV section of the Federal return in TurboTax including exempt-interest dividends.
• Click Continue
• At the screen "Tell us if any of these uncommon situations apply to you", check the box next to "A portion of these dividends is U.S. Government interest". Click Continue.
• The next screen states "Enter U.S. Government Interest". Enter the amount in the box provided. Click Continue.
• The next screen asks which state(s) your exempt-interest dividends are from. You can enter the amount for each state here. Click Done.

The Learn More link in one of these steps explains:

The U.S. government taxes income you receive on its own bonds. Your state does NOT tax income from U.S. government bonds, but each state defines government bonds differently. You should check to see if any part of these dividends is taxable in your state. This information is usually included with the 1099 you received from your broker. You may also be able to get this information from your mutual fund company's website.

Based on this information, enter an adjustment for the amount your state does NOT tax, and the TurboTax State program will subtract this amount from your state.

Form 1099-DIV is used by banks and other financial institutions to report dividends and other distributions to taxpayers and to the IRS. See the Instructions for Form 1099-DIV for more information.

I am elevating this issue for review; however, as you noted, there was no tax consequence from reporting the interest as a dividend.

[CelBar]

Hi, thank you for elevating the issue for review.

Yes, I understand how I am supposed to enter into Turbotax the information about the non-taxable interest on U.S. bonds that was reported on a 1099-DIV. I already followed the steps you describe. The point of my post was not that I did not understand everything you explain, nor that I had not already followed the steps. The only point of my post was that once one follows the steps in Turbotax to report the non-taxable interest, Turbotax incorrectly enters this adjustment on the wrong line of the California form 540-CA. It seems like Turbotax should get this right.

In addition, since the correct way to do this is plainly explained in the California instruction booklet for form 540, it comes across like whoever coded Turbotax's software for California did not read the California instructions, but rather just looked at the form an made an (incorrect) assumption. This is not confidence inspiring. I happen to have already been very familiar with the proper way to make this particular adjustment on a California return. But how do I know what other areas Turbotax is getting wrong, where I'm less familiar with the tax rules, that might have actual consequences for one's taxes? The whole point of Turbotax is to make these things easy, but if you can't trust it, then what's the point.

I can also see that the state taxes section of these forums are riddled with complaints about Turbotax making errors. It's not impressive. Turbotax has one job, to get these things right. It shouldn't be that hard, to just read the instructions for individual state taxes.

[MBAFinance]

My financial institution does not report the purcahse and sales of US treasury/bonds on 1099-DIV. It sends that information to the IRS and me on 1099-B. I entered my long term capital gains from the US Treasury on under Stocks and Bonds Sale (Under Turbo Tax Perosnal Income section). The Federal TAX box went up immediately as expected (IRS taxes gains from sale of US notes/bonds) but so did my California State Taxes by a certain amount. Why is not Turbo Tax for California exempting me from the gains from trade in the US treasurey? Where do I make the adjustments to get teh state exemption?    

[CelBar]

There is no exemption for gains from sales of US Treasury bonds (either individual bonds sold on the secondary market or the sale of shares in a mutual fund or EFT that holds these bonds). Those gains are capital gains, based on the change in value of the bond or the shares in the fund you sold from when you originally purchased the bond/shares. You pay capital gains tax on that, as you would on the sale of any asset (of course it's also possible to have a capital loss, which would reduce your taxes). Capital gains and losses are reported on a 1099-B. There is no California adjustment for capital gains on the sale of such bonds/shares (and I believe California treats capital gains like ordinary income--which differs from how the federal government treats them).

What I'm talking about in this thread are the dividends/interest that one earns while holding US Treasury bonds (or shares in a fund that holds these bonds). That is dividends/interest that is paid out to you over the course of the year, while you continue to hold the bonds/shares and has nothing to do with the sale of those bonds/shares and the gains/losses that may occur upon sale. This type of dividend/interest is reported either on a 1099-DIV (mainly for funds, I believe) or a 1099-INT (if, I believe, you are holding actual individual bonds). You get an adjustment for that on your California taxes.

It is common to get both a 1099-DIV and 1099-B from a financial institution (or a consolidated form that includes both) for the same fund. For example, if you hold shares in a mutual fund that produces dividends, but you sell some of those shares over the course of the year, then you will get a 1099-DIV reporting your dividend income from the fund during the year and a 1099-B reporting your capital gain/loss from the shares you sold. So depending on the activity with the mutual fund or individual bonds over the course of the year, you could get one or the other or both of those forms.

[ddy720]

I know your post is about something else, but where can I find confirmation that capital gains from the sale of US Treasury bills is not exempt from California state income tax?

[CelBar]

I think the only place you can get official confirmation that capital gains on US treasuries do not get an exemption on California taxes would be to read the California instructions and publications about capital gains. I'd look first at the instructions in the booklet, regarding adjustments made on form 540-CA, on the line about capital gains. Perhaps there are also some other publications that can be found on the franchise tax board website about this.

That being said, I've dealt with treasuries on my taxes for a long time and I'm pretty certain that the exemption you are imagining does not exist. The exemption is only for dividends/interest. I have never once anywhere seen any other exemption mentioned. Of course, I'm just some person on the internet. You could search around online to see if you find anyone discussing this. But that would also be just people on the interent saying things.

At the end of the day, reading the California instructions and booklet is really the best choice. It's is the official word on all such matters. And frankly, I often find the California (and IRS) booklets to be much clearer (and more detailed), as well as up to date, than information that Intuit provides or than what I see on these forums. 

[ddy720]

Thanks for your reply.  I looked at the California instructions and pamphlet on capital gains and the material was silent on the subject. I spoke to someone at California FTB on the phone today and they said capital gains on treasuries are not taxable by California. But frankly I’m still not convinced. 

[MonikaK1]

If you have US Government Interest such as from a savings bond that you redeemed, e.g., a Series EE Savings Bond, and it is reported as Dividends on Form 1099-DIV:

• Enter your Form 1099-DIV exactly as the boxes appear in the 1099-DIV section including exempt-interest dividends.
• Click Continue
• At the screen "Tell us if any of these uncommon situations apply to you", check the box next to "A portion of these dividends is U.S. Government interest". Click Continue.
• The next screen states "Enter U.S. Government Interest". Enter the amount in the box provided. Click Continue.
• The next screen asks which state(s) your exempt-interest dividends are from. You can enter the amount for each state here. Click Done.

The Learn More link in one of these steps explains:

The U.S. government taxes income you receive on its own bonds. Your state does NOT tax income from U.S. government bonds, but each state defines government bonds differently. You should check to see if any part of these dividends is taxable in your state. This information is usually included with the 1099 you received from your broker. You may also be able to get this information from your mutual fund company's website.

Based on this information, enter an adjustment for the amount your state does NOT tax, and the TurboTax State program will subtract this amount from your state income.

Interest income from Treasury bills, notes, and bonds is subject to federal income tax, but is exempt from all state and local income taxes. See this IRS webpage for more information.

When you lived in more than one state during the tax year, you should prepare the earlier nonresident/part-year resident state return first and then the return for the state where you lived at the end of the year, to get correct results. If you prepared them in the wrong order, you can delete them and start again.

Different states treat the income allocation calculation differently. Complete the TurboTax interview for the earlier state, and make the correct interest income adjustment where prompted. When that return is complete, then complete the state interview for the later state. See this TurboTax help article for more information about splitting income between states.

See this TurboTax tips article for more information regarding bonds.

@ddy720 @CelBar