Penalties and interest

Forum|Forum|3 years ago
July 25, 2023
6 replies
59 views

My wife and I were audited by NC this year for 2019, 20, & 21. I was informed by OPM that my wife qualified for the Bailey Settlement which excludes her from paying state taxes on her annuities. She doesn’t qualify and we got slapped with a hefty bill of 3 years of back taxes, penalties, and interest. We took out a second mortgage and paid the state and I applied for consideration to receive the penalties and interest be refunded. The state has refunded us for the penalties and some of the interest charges. My question is does this refund of my debt in penalties and interest count as income on my federal or state taxes? I don’t think it should because I haven’t really gained anything but received basically a reduction in funds owed. I know this is a tough question and I am grateful for the person who can help me!

rjs

Level 15

The refund of penalties and interest is not income and you do not report it on your federal or state tax returns.

(If you had claimed an itemized deduction for the penalties and interest on your federal tax return for the year that you paid them, then you would have to report the refund as income. But you should not have claimed a deduction for the penalties and interest because they are not deductible.)

CHUCKles4meAuthor

Level 2

Thank you!

Opus 17

Level 15

You were entitled to claim the state income taxes you paid as a federal itemized tax deduction in the year you actually paid the taxes, regardless of the years they were assessed for. (Subject to the overall $10,000 cap on deducting state and local taxes.) However, you can not claim an itemized deduction for penalties or interest.

If you accidentally took a deduction that included the penalties and interest, you would have to amend to fix that. However, if you never deducted the penalties and interest, then a refund of those amounts is not taxable income to you.

CHUCKles4meAuthor

Level 2

Thank you for your valuable information! We haven’t claimed anything yet, we were just assessed this year for 2019,20,&21. We recently paid the state. So can I claim what we owed/paid this year next year, or can I claim each year over the next 3 years? In other words, can I claim the amount in taxes owed to NC in 2019 in 2023 taxes, 2020 in 2024, and 2021 in 2025? Each year we could easily claim the maximum of $10,000, and that doesn’t include any interest or penalty. I’m thinking though I can only claim what I actually paid this year for 2023 taxes, which grossly exceeds $10,000. Because this was deemed a honest mistake and because I have never tried to defraud the government on my taxes, the state graciously agreed to refund my penalty and some interest. I was worried that the amount they refunded would have to be reported as income even though it wasn’t income but a reduction in what we owed/paid. I still paid over $6,000 in interest.

Opus 17

Level 15

@CHUCKles4me

State taxes that are actually paid in 2023 are only deductible on your 2023 tax return, even if they exceed the $10,000 cap. You can't stretch the deduction out over time. That's one of the ways the SALT cap works to increase tax revenue to offset some of the other tax savings in the 2017 tax reform law (like reducing the actual tax rates from 15% to 12% and from 25% to 22%). The cap does have an impact on people who, for whatever reason, pay large amounts of state tax.