Dick Weaver wrote:

- quote -

The argument is simple--it's a pure issue on the method of
accounting. A taxpayer who has elected to use the cash
method of accounting (you remember making that election,
right??? <grin> ) has to work that way. Under Section 446
it's the cash method of accounting you are under, and under
Section 441 the computational period is annual and Section
461 puts the deduction for a cash basis taxpayer in the year
paid.

Assuming you did not have the consent of the IRS to change
your method of accounting for state income taxes as required
by Section 446(e), the IRS has absolute authority to force
you back on your "old" (and arguably proper per the cash
basis) method of accounting.

Now, if you had elected to use the accrual method of
accounting, this problem wouldn't exist. And Section 446
gives you that option--though I'm pretty sure most
individual taxpayers won't use it <grin> .

--
Ed Zollars, CPA
Phoenix, Arizona

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Stuart O. Bronstein wrote:

- quote -

And in this case, the only "income" is the incorrect
recovery mathematics of the IRS. (the IRS mathematics
assume that next year is pretty much like last year, same
tax brackets etc., but instead of subtracting the recovery
from next years deduction - whether itemized or standard(!)
- they add it to the AGI).

So it is the IRS, not the taxpayer, that distorts income!

The taxpayer is reducing the claimed deduction so as to not
materially distort next years income!!

dick w

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Ed Zollars, CPA wrote:

- quote -

The IRS method of recovery for deductions, adding to next
years AGI, has sometimes made the National Taxpayers
Advocate list of "Top 20 Tax Problems" (didn't check 2002,
their report is too large for my dialup access).

Since the problem begins with a mistake by the taxpayer, the
overpayment of state tax, I can't see an argument that the
government's interests were harmed by not claiming the
overpayment as a deduction (I'll admit to not "seeing" a lot
of what the government is doing these days).

dick w

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"Ed Zollars, CPA" <ezollar[at]mindspring.com> wrote:
- quote -

The courts generally give the IRS the right to do that.
Based on Sections 446 and 461, the courts let the IRS
disallow any deduction which is deemed to materially distort
income.

See LILLIE v. COMMISSIONER OF INTERNAL REVENUE, 45 T.C. 54 (1965)
and SANDOR v. COMMISSIONER OF INTERNAL REVENUE, 62 T.C. 469 (1974).

Stu

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Dick Weaver wrote:

- quote -

Not dispositive here--the catch is that IRC Section 63(b)(1)
makes it clear that anyone can *elect* to use the standard
deduction in lieu of itemizing. However, if you have not
made the election to use the standard deduction, then the
open question is whether you can "fine tine" the deductions
on your return by not claiming some would otherwise be
legally entitled to.

I participated in a discourse with Jim Maule and Rod Goodwin
over on ABA-TAX where we dealt with this issue. The answer
we arrived at seemed to be it's tough to find a definitive
answer, but there are clearly specific cases (especially
involving the earned income credit) where the IRS has taken
a strong position that a taxpayer could *NOT* ignore
deductions legitimately allowed when, by doing so, the
government's interests were harmed.

Note that Section 164(a) provides that the deduction *shall*
be *allowed* for taxes paid in the year paid (for cash basis
taxpayers--the "accrued" line would apply for accrual
taxpayers). Now shall argues for a requirement, but allowed
could be read to suggest that maybe they have to first be
claimed <grin> . However, Section 1402(a), which is the
definition the earned income tax credit references, uses the
same "allowed" word and the IRS has been pretty clear that
they do not believe you can "fine tine" your self-employment
income to maximize your earned income credit by leaving out
deductions.

My own take is that the IRS position is pretty much this--if
you've figured out a way to improve your position by leaving
off deductions, they will generally take the position that
you can't leave them off. Normally this is a more
theoretical position, since quite often the IRS has a
problem with proving those deductions. However, if you are
*amending* a return previously filed, the IRS's job is a lot
easier.

Now, you clearly could file an amended return to elect the
standard deduction and then not have to report the refund in
the following year. With the election made under Section
63(b)(1) that deduction is in lieu of the itemized
deductions and the IRS has no method of putting those amount
back on the return. But I suspect in the case at hand that
this would not be a good result <grin> .

--
Ed Zollars, CPA
Phoenix, Arizona

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Mark Freeland wrote:

- quote -

No, the deed is already done, and you did get the 4K refund
duly reported by the state and therefore income in 2003. If
you did go back and amend 2002 to reduce the state income
tax deduction, the refund you got is STILL income taxable
to you in 2003.

Happy New Year!
Harlan Lunsford, EA n LA

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Mark Freeland wrote:

- quote -

I've been hoping one or more of the professionals would
reply to your post, but that hasn't happened. So....

There have been numerous m.t.m threads on state tax refunds
and federal taxes. You can locate many of them by a Google
search of m.t.m and author=rweaver[at]ix.netcom.com. I seem to
have a (bad) habit of posting to such threads. About the
most recent thread is "Federal income tax on state refund".
You can skip it, was immediately sidetracked.

The threads have confirmed that you are not required to
claim all deductions. The stated proof: someone who takes
the standard deduction when they could have done better by
itemizing has not broken the law.

So - if you don't have to claim all deductions and since you
are allowed to file amended returns, it would follow that
you can file an amended return to reduce deductions. I've
done just that, more than once, to escape disastrous state
refund taxation (SS lump sum, insurance repayments, multiple
years, ugh).

More correctly, it would follow IN THE ABSENCE OF A SPECIFIC
IRS RULING - and in the m.t.m threads that I've read there
has never been a hint of such a ruling.

I've also never asked your question explicitly here - if it
is not allowed, I'd rather submit incorrect returns because
I didn't know, that know and have to submit much more costly
returns! Should be an old saying "Don't ask questions you
don't want the answers to".

For the future: never claim all deductions on 1st filing,
wait for the dust to settle and always file an amended
return. When you are old, getting SS payments, there are
income ranges where itemized deduction recovery can cost
almost 2x the prior year tax "saving". And that is just one
of AGI impacts.

dick w

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Attempting to reduce this year's income, I'm wondering about
reducing the income due to refund of last year's state
taxes. Specifically, by disclaiming part of the deduction,
retroactively.

Numbers below are hypothetical:

2002:
10K paid in state taxes (withholding, estimates, refund not
taken, etc.)

April 2003:
2002 State return filed; 6K due, 4K refund.
2002 Fed return filed, deducting 10K in state taxes for 2002.

January 2004:
Receive 1099-G reporting 4K in state tax refund.

That 4K is income for 2003 because it was deducted on the
2002 fed return.

Could I file an amended 2002 Fed return, declaring only 6K
in state taxes?

Obviously, I would owe 2002 taxes on 4K more income (since I
wouldn't be deducting the 4K in state taxes). Would I owe a
penalty, if so, how is it computed and are there other
ramifications?

Would the 4K refund no longer be part of my AGI (i.e. would
it no longer be a *taxable* refund)? The 1040 line 10
instructions do acknowledge special cases where the state
refund is not taxable because one did not get a deduction
(e.g. when paying AMT), but it doesn't address the question
of voluntarily underreporting state taxes.

Thanks for any thoughts or pointers.

--
Mark Freeland
nBeOwXs[at]pacbell.net

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