Why are State Tax Refunds Taxible in TT?

[mrwzzrd]

Now that state taxes are no longer deductible even when itemizing deductions, why is Turbo Tax still indicating that State Tax Refunds are taxable? This makes no sense.

I over estimated my state taxes by $12,000 so I got a state refund of $12,000. On my federal return, I itemized my deductions however State and Personal Property tax deductions are limited to $10,000. So why is TT indicating that my $12,000 is taxable? This seems wrong. I didn't get a tax benefit from the refund.

[DoninGA]

State and Local income taxes are most certainly deductible as an itemized deduction on Schedule A.  There is a limit  on State/Local income taxes plus property taxes of $10,000 ($5,000 if filing as Married Filing Separately).

[DoninGA]

TurboTax follows IRS rules for calculating the taxable portion of a State or Local refund.

IRS Form 1040 instructions for 2019 (draft) State and Local Income Tax Refund Worksheet page 83 - https://www.irs.gov/pub/irs-dft/i1040gi--dft.pdf#page=83

[Critter]

FYI ... the 2019 downloaded version is not fully operational yet and will not be until all the IRS forms are made final along with all the instructions.  This first beta version will need many updates over the next 3 months and until then you should not be surprised that it is not working correctly ... as always patience will be needed until the program is fully functional. 

[mrwzzrd]

In Pub 525 under state tax refund, it states that the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you didn't choose to deduct for that year.

The way I read this is since my State and Personal property was limited to $10,000, the $12,000 refund should not be taxable because I was NOT able to deduct all of my state taxes of $132,000. 

The fact that TT marks all $12,000 as taxable is a bug. I am being double taxed on at least $2,000 (or not getting any tax deduction benefit on the $10,000 deduction). 

[Critter]

AGAIN .... the 2019  program is NOT NOT NOT fully operational yet !!!!

It is still using the 2018 forms, rules and instructions in MANY places  so it is NOT NOT NOT calculating this correctly ... PATIENCE is needed  until at least the end of January. 

[rjs]

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@mrwzzrd wrote:

In Pub 525 under state tax refund, it states that the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you didn't choose to deduct for that year. 

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You are misreading Pub. 525. The sentence you are referring to applies to the choice of deducting either state income tax or sales tax. What it is saying is that, if you deducted state income tax in 2018, the maximum refund that you may have to include in income in 2019 is limited to the excess of state income tax (the tax you chose to deduct) over the amount of sales tax that you could have deducted (the tax you didn't choose to deduct). That's probably a lot more than $2,000.

The rules for calculating the taxable amount of an itemized deduction recovery are long and very complicated. They cover about four pages in Pub. 525. You can't reduce those rules to one sentence. Read the whole section on recoveries very carefully.

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@mrwzzrd wrote:

I was NOT able to deduct all of my state taxes of $132,000.  

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If your income or property value is so high that you paid $132,000 of state tax, you should be having your tax return prepared by a professional, not doing it yourself with TurboTax.

[mrwzzrd]

“If your income or property value is so high that you paid $132,000 of state tax, you should be having your tax return prepared by a professional, not doing it yourself with TurboTax.”

It is very expensive to live in CA!

oh come on! Successful people don’t need to pay someone to do their taxes. Maybe if there are complicated tax situations but generally TT is just fine. 

[mrwzzrd]

Based on this document from the IRS, Turbo Tax is not handling State Refunds correctly.

https://www.irs.gov/newsroom/with-new-salt-limit-irs-explains-tax-treatment-of-state-and-local-tax-r...

There is a link to a PDF with multiple examples. The second example explains that IF the amount of State and Local property taxes, that were limited to the SALT limits, if the state refund does not change the itemized deductions, then you are not required to include the refund in gross income. 

In other words, if your itemized deductions are limited to $5,000 for individual/$10,000 married joint return, if the refund does NOT reduce the State and Local taxes to the point that the itemized deductions are changed (i.e. still limited to $5,000 or $10,000), then you didn't received a tax benefit from the refund thus the refund is not taxable.

Situation 2: Taxpayer B paid local real property taxes of $5,000 and state income taxes of $7,000 in 2018. Section 164(b)(6) limited B’s state and local tax deduction on B’s 2018 federal income tax return to $10,000, so B could not deduct $2,000 of the $12,000 state and local taxes paid. Including other allowable itemized deductions, B claimed a total of $15,000 in itemized deductions on B’s 2018 federal income tax return. In 2019, B received a $750 state income tax refund due to B’s overpayment of state income taxes in 2018.

Situation 2: Taxpayer B paid local real property taxes of $5,000 and state income taxes of $7,000 in 2018. Section 164(b)(6) limited B’s state and local tax deduction on B’s 2018 federal income tax return to $10,000, so B could not deduct $2,000 of the $12,000 state and local taxes paid. Including other allowable itemized deductions, B claimed a total of $15,000 in itemized deductions on B’s 2018 federal income tax return. In 2019, B received a $750 state income tax refund due to B’s overpayment of state income taxes in 2018.

I understand that Turbo Tax is not complete yet however these rules are the same as 2018 as well and my $1200 refund was marked as taxable by Turbo Tax in 2018. Their calculation is wrong.

[mrwzzrd]

This is the second part of the example (pasted the first part twice)

Situation 2: State income tax refund not includable. In 2019, B received a $750 refund of state income taxes paid in 2018. Had B paid only the proper amount of state income tax in 2018, B’s state and local tax deduction would have remained the same ($10,000) and B’s itemized deductions would have remained the same ($15,000). B received no tax benefit from the overpayment of $750 in state income tax in 2018. Thus, B is not required to include the $750 state income tax refund in B’s gross income in 2019.

[DoninGA]

@mrwzzrd Your question has been reported to the TurboTax Moderators and is being investigated.  This may already have been in the program schedule for correction in a future update.

News Release:  https://www.irs.gov/newsroom/with-new-salt-limit-irs-explains-tax-treatment-of-state-and-local-tax-r...

Revenue Ruling and examples:  https://www.irs.gov/pub/irs-drop/rr-19-11.pdf

[Lisa995]

I wouldn't count any anything state related to be fully functioning correctly until the state modules become available.

[mrwzzrd]

This issue isn’t related to state taxes. The issue is whether the previous years state refund is taxable in this years federal return. 

Spoiler

[tagteam]

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@mrwzzrd wrote:

The issue is whether the previous years state refund is taxable in this years federal return. 

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See the information at the IRS web site (link below).

https://www.irs.gov/faqs/interest-dividends-other-types-of-income/1099-information-returns-all-other...

[rjs]

@mrwzzrd  As Critter said near the beginning of this thread, the initial release of the new tax software is known to be incomplete. It will be refined by numerous updates over the next couple of months. The calculation of the taxable amount of a state income tax refund has not yet been updated to account for last year's tax law changes. The IRS has not yet issued final instructions for this calculation for 2019. The TurboTax staff is aware that this needs to be updated. After the IRS has issued the final instructions, TurboTax will be updated to do the calculation correctly. At this time there is no date set for when this update will be done.