Dick Weaver <rwea...[at]ix.netcom.com> wrote:
- quote -

Did you mean "Provided only that not claiming the deduction
LOWERS your federal taxes (think AMT, for an example) then
you are not required to claim the deduction"?

There used to be a situation where not claiming a deduction
reduced the AMT because of a drafting error related to the
way capital gains were taxed under the AMT but Congress
fixed that a couple of years ago.

Cheers,
WDK

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- quote -

My late husband did the same thing for about 15 years, from
the early 1960's to the mid 1970's when I went back to
school and studied taxes and figured out that he was wrong!
And the IRS never questioned us either. But that doesn't
mean it was right.

As a cash method taxpayer you deduct the tax you paid during
the year -- not the actual tax liability shown on your
return for that year. That would be the accrued tax, not the
tax paid.

Katie in San Diego

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"Shyster1040" <Shyster1040[at]nospamhotmail.com> wrote:

- quote -

If true then that's the ultimate tax straddle. Are there no
limits?

- quote -

That would be the point - a deduction in year 1 and shifting
that income to year 2. If I have a particularly good year
that puts me into a higher tax bracket, overpaying state tax
this year can be a way to keep the extra income in a lower
bracket by shifting it to next year when I don't expect to
make as much.

Stu

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As I discuss in (perhaps unnecessary detail) in another post
on this thread, voluntarily choosing to claim a deduction
for less than all of the state income tax you actually paid
in Year 1 will not, of itself, permit you to exclude from
income for Year 2 the state income tax refund you receive in
Year 2.

The rationale turns on the fact that both Section 111 (which
permits the excusion of recoveries of amounts paid that were
allowable as a deduction but did not actually reduce your
tax liability for the year in which allowed) and the tax
benefit rule turn on whether or not a deduction was
"allowed" in the prior year for an amount paid in that prior
year, and not on whether the deduction was actually
"claimed" for that prior year.

Thus, even if you don't claim the deduction for 2006, you
will still be required to include the refund in income for
2007 if the deduction was allowed for 2006 under Sec. 164.
You will therefore merely overstate your income for 2006
without being able to understate your income for 2007.

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As a general rule, you cannot reduce your claimed deduction
for state taxes paid for the current year's federal income
tax return by the amount of any state tax refund you
anticipate receiving in the next year.

Code Sec. 164 allows a deduction for the taxable year in the
amount of any state taxes paid or accrued within that
taxable year. Since most individuals are cash-method
taxpayers, the operative word is "paid."

The general effect of this provision is that, if in Year 1
you remitted an amount to a state taxing authority in
payment of your state tax liability, that amount is an
amount of state taxes "paid" within Year 1 and the deduction
therefore is only allowed for Year 1.

Under the general rule of Section 61, assisted by the tax
benefit rule (see, e.g., Arrowsmith v. Commissioner), a
recovery or reimbursement in Year 2 for any amount of state
taxes paid in Year 1 is included in gross income in Year 2,
except to the extent that (a) the deduction allowed for that
amount in Year 1 did not reduce the income tax due for Year
1, see Section 111, or (b) no deduction was allowed
(emphasis on "allowed," not on "claimed") for Year 1, see
the tax benefit rule.

It needs to be emphasized that the focus under both Section
111 and the tax benefit rule is the degree to which a
deduction was "allowed" for Year 1, not the degree to which
such a deduction was actually claimed.

Thus, if you actually paid $500 to State A as State A income
tax in Year 1, you are allowed a deduction of $500 for Year
1 under Sec. 164. If you choose, instead, to claim a
smaller amount, that is your choice, and you cannot rectify
the effects of that choice in a later year (i.e., you must
amend the return for Year 1 to claim the greater deduction -
the amendment is permitted because the event on which the
amendment is based, actual payment, occurred in Year 1).

If in Year 2 you receive a refund from State A of overpaid
State A income taxes for Year 1 in the amount of $100, you
must include that $100 in income for Year 2 unless either
(a) claiming the deduction for that amount on your Year 1
return did not reduce your Year 1 federal income tax, see
Section 111, or (b) no deduction was allowed for that amount
in Year 1.

Thus, if you intentionally overpay your State A income tax
in Year 1 by $200, and receive a refund of that amount from
State A in Year 2, you must include that $200 in income for
Year 2 regardless of whether or not you claimed a deduction
for that amount in Year 1 unless either (a) claiming the
deduction would not have reduced your tax due for Year 1
(Sec. 111) or (b) a deduction for that amount was not
allowed for Year 1.

As a result, unless you can prove that, under some theory,
you would not have been allowed a deduction for that $200 in
Year 1 under Sec. 164, or you can prove that your Year 1 tax
liability would not have been reduced had you in fact
claimed a deduction for Year 1 of that $200, then you must
include that $200 in your gross income for Year 2.

Thus, if in Year 1 you anticipate that you will be getting a
refund in Year 2 of $x of state income tax you actually paid
in Year 1, you will only be hurting yourself because you
will have overstated your income for Year 1 without being
able to rectify that situation by understating your income
for Year 2 by not reporting the refund received in Year 2.

The rationale for this is: you were allowed (again, emphasis
on "allowed" not on "claimed") a deduction in Year 1 for the
$x you paid in Year 1, and thus you cannot exclude that
amount from your Year 2 income under Section 111 because
that section only applies to deductions "allowed" that did
not decrease your Year 1 tax liability, and without any
other facts, your Year 1 tax liability would have been
reduced had you in fact claimed the allowed deduction of $x
in Year 1. By similar reasoning, under the tax benefit
rule, since you were allowed a deduction for that $x in Year
1, you must include the refund received in Year 2 as income
for Year 2.

The reason why you cannot simply amend your Year 1 return to
claim the lower deduction on account of the receipt of the
refund in Year 2 is because of the general principle that
each tax year must stand on its own, and each year's tax
liability is determined based on the events occurring during
that year. Since you actually paid $x in Year 1, and did
not receive the refund of $x until Year 2, the only relevant
event that can be taken into account in determining your tax
liability for Year 1 is the fact of payment of $x; since the
offsetting refund received did not occur until Year 2, it
cannot be taken into account in determining your tax
liability for Year 1.

However, you can amend your Year 1 return to increase the
deduction you claimed (to the extent of your actual payments
made during Year 1) for the same reason - the payment took
place in Year 1 and thus the only tax year in which it can
be taken into account is Year 1. As a result, if you
initially failed to take that payment into account on your
initial return for Year 1, you may amend your Year 1 return
to take that payment into account and claim the larger
deduction for Year 1. As a corrollary, you cannot take the
additional deduction on your Year 2 return because the
relevant event, payment of $x, occurred in Year 1 and
therefore cannot be taken into account in Year 2, or any
other year other than Year 1.

That, in a nutshell explains why you can amend your Year 1
return to claim a larger deduction, but cannot amend your
Year 1 return to claim a smaller deduction (unless, of
course, you really didn't pay in Year 1 the amount claimed
as a deduction for Year 1, in which case you should amend
your return to claim the smaller deduction).

Finally, the topic of making a "bad-faith" payment in Year 1
was raised. Another general principle of tax-law is that a
deduction claimed for a payment made is only allowed if the
payment actually made comports with the substance of the
rationale for which the deduction was allowed - i.e.,
substance over form. Sec. 164 only permits a deduction for
state taxes, a tax being a compulsory levy, and not for
voluntary payments. Thus, if under all possible
circumstances your state tax liability for Year 1 would
never exceed $500, and if you paid $1,500 to the relevant
state taxing authority in Year 1 at a time when it was, or
should have been, obvious to you that your tax liability was
only $500, then you would not be permitted to claim a
deduction for the excess $1,000 payment you made because
that payment was in substance a purely voluntary payment and
bore no relationship to the sort of compulsory levy that
constitutes a "tax." It should be noted, this is a case-law
doctrine, not a Code provision, so you won't find any
section in the Code that explicitly imposes this limitation.

As a result, when you receive a refund of $1,000 from the
state in Year 2, that $1,000 would not be included in gross
income for Year 2 because, under the tax benefit rule, that
refund represents a recovery of an amount paid in Year 1
that provided no tax benefit in Year 1. It should be noted,
however, that the state will provide you with a 1099, and
the refund will be reported to the IRS, which will be
expecting that amount to be included in income, so you had
better attach a Disclosure Statement to your Year 2 return
explaining why you did not include the amount in income;
otherwise, you will most assuredly be assessed a deficiency
for Year 2.

It should also be noted that trying to prove that your
overpayment of state tax in Year 1 was not in good faith and
that therefore a deduction for the overpayment would not
have been allowed for Year 1 under Sec. 164 is an extremely
hard uphill battle. You will, generally, be bound by the
consequences of your own actions, and will generally not be
permitted to gainsay those actions at a later date - this is
analogous to the doctrine that, absent a showing amounting
to fraud, a taxpayer is generally not permitted to deny or
disclaim the form in which he chose to cast his transactions
(see, e.g., Moline Properties). As a result, the IRS will
almost always prevail on the argument that (a) you were
allowed a deduction in Year 1 for the amount of the
overpayment and thus (b) you are required to include the
amount of the refund as income in Year 2. The fact that you
didn't actually claim the deduction in Year 1 will,
generally, be irrelevant to the issue of whether the refund
must be included in income for Year 2, and your only remedy
will be to file an amended return for Year 1 to claim the
additional deduction.

This result is part of the more general principle that your
tax returns should reflect your true income, and that income
and deductible expenses be matched on an annual accounting
period basis. In other words, allowing you to voluntarily
overpay your state taxes in Year 1 and claim a deduction
therefor, and to then report the refund thereof as
additional income in Year 2 would be to permit you to
massage your income solely for the purpose of tax
minimization, and would flout the requirement that your
returns clearly reflect your economic income.

The bottom line is: you really cannot "manage" your income
by netting an anticipated Year 2 refund of state tax against
the amount of state tax actually paid in Year 1 in order to
claim a smaller deduction for Year 1. Additionally, while
you can probably engage in some small-scale income shifting
by overpaying your state taxes in Year 1, you are unlikely
to get much benefit out of doing so if your intentional
overpayment so grossly exceeds your actual state tax
liability that your Year 1 deduction will be denied. While
an exorbitant claim would probably get through the initial
automated review, the exagerated claim would most likely
trip the DIFF score red-flag, and would result in an audit
for Years 1 and 2.

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- quote -

Maybe I have done it wrong for 50 years, but this is what I
do and I haven't heard a peep out of the IRS yet (it's a
moot point with me now since I am retired and no longer
itemize).

When preparing my taxes I figure the fed and state (CA)
taxes. The figure that I use on the federal form for
itemizing state taxes is the actual calculated _tax_ paid
for the tax year regardless of the amount withheld if the
withholding was more. The next year I do not list the
refund at all because I never deducted it during the
previous year.

I have always figured that there is a difference between the
_tax owed_ (the actual amount that the state wants for the
tax year), and the _amount withheld_ (a wild ass guess as to
what the actual tax might be, but often wrong). I have
always disregarded the withheld amount (for federal
deduction of state taxes) and used the actual number
instead. The IRS has always accepted this.

--
-Ernie-

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- quote -

Won't work due to my particular numbers.

- quote -

That is one of the ideas on the table, and there's some
support for it in the link in Hiker's post to this thread.

Steve

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Hiker <hiker410[at]yahoo.com> wrote:

- quote -

Thanks, that seems very useful. The part that one cannot
amend to take a lower deduction (only higher) is very
interesting; I hadn't heard of that before.

My EA is planning to run several scenarios and then I can
combine that information with all the seemingly subjective
info on IRS positions and make a decision which way to go.

Steve

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The IRS instructions are pretty clear that the state tax
refund is taxable only to the extent that you got a benefit
the previous year by deducting the corresponding state tax
withholdings or estimated payments. See the instructions
for line 10 of 1040, which has a worksheet. It also refers
you to Pub. 525 for more complex situations (i.e. if you
didn't benefit from the deduction due to deduction phase-out
or paying the AMT, among other reasons).

There is a thread on the fairmark message board that has
just gotten into a related topic, although the thread
started on a different topic. It discusses whether you have
the option to not deduct the full state tax paid in one year
in anticipation of a refund the next year. The conclusion
seems to be that you can.

http://fairmark.com/forum/read.php?5,11659

Steve


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- quote -

I looked at line 10 of the 2006 1040. It says to look on
page 24. Page 24 says:

"None of your refund is taxable if, in the year you paid the
tax, you either (a) did not itemize deductions, or (b)
elected to deduct state and local general sales taxes
instead of state and local income taxes."

it also says "If the refund was for a tax you paid in 2005
and you deducted state and local income taxes on line 5 of
your 2005 Schedule A, use the worksheet below to see if any
of your refund is taxable."

This sounds simple enough, but are you suggesting you will
deduct in 2005 not ALL of your state income tax payments?

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- quote -

Yes, that's the gist of the problem here. I risk paying
double Federal tax on the amount I overpaid.

My belief is that if I simply don't deduct the excess
estimated tax payments, and then try to claim I don't owe
tax on the refund (since it was never deducted), while this
seems righteous I will lose (although if anyone has tried
exactly that, I'm interested to hear what happened.).

(And whether I use the refund to pay future state tax
is immaterial.)

Steve

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Thanks to all who replied. Since I am below the AGI
threshold that limits itemized deductions, the benefit of
the deduction of the full amount of state estimated tax paid
will be limited only by AMT. And the way I read pub 575, I
will get this AMT back when in the following year I compute
the amount of the state refund that is taxable.

(True?)

The amount of state estimated tax I overpaid in 2006 is
large, but the total is still only about 2/3 of my 2005
state tax liability, so I think I'm okay as far as claiming
it goes.

Steve

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- quote -

A state tax credit that rolls to your account for next year
is still reported by the state on a 1099G and may be
reportable on Form 1040 Line 10.

__
Art Kamlet ArtKamlet [at] AOL.com Columbus OH K2PZH

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Steve Pope wrote:

- quote -

Steve, you may choose to use the sales tax deduction which
will result in no income reporting of the refund of state
taxes. You may also deduct only the taxes actually paid for
state taxes, and choose to allow the state to keep the
refund for the next year taxes as well.

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Steve Pope wrote:

- quote -

Provided only that not claiming the deduction does not lower
your federal taxes (think AMT, for an example) then you are
not required to claim the deduction.

dick w

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"Steve Pope" <spope33[at]speedymail.org> wrote

- quote -

In this case, you are free to not claim as as itemized
deduction, all that was withheld/paid.

--
Paul A. Thomas, CPA
Athens, Georgia

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"Steve Pope" <spope33[at]speedymail.org> wrote:

- quote -

Claiming only part of your payment on Schedule A won't help.
The only thing that would make the refund nontaxable would
be not itemizing on 2007. This doesn't make much sense to
me off the top of my head, but you could always file 2006
with the standard deduction, wait until the 2007 dust
settles, and then amend 2006 to itemize if it turns out that
was the way to go.

--
Phil Marti
Clarksburg, MD

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I'm in a situation where the amount I paid California in
2006 estimated tax payments during 2006 is considerably
more than my actual tax liability.

Is it possible to not claim the excess amount paid on
Schedule A, such that the refund received in 2007 becomes
not federally taxable? If not, are there any other
strategies? (Not itemizing in 2006 seems one approach.)

Thanks,

Steve

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