- quote -

If the taxpayer had claimed only the actual state income tax
owed none of the refund would be taxable. See section
111(a) of the Internal Revenue Code.

Cheers,

WDK

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- quote -

Using the OP's numbers, you're right. If his 2005 AGI was
$445,950, then (and only then) would his itemized deduction
limitation be $9K. In this case if he had only deducted the
$32K actually owed for state tax, his total itemized
deductions would be $41K, his limitation would still be $9K,
and the full $13K refund would therefore be includable in
taxable income. So to the extent that some of the previous
replies were assuming an AGI of $445,950, they were correct.
(That is, unless this taxpayer were subject to AMT -- we
don't have enough information).

The limitation based on an 80% reduction of affected
deductions is not advantageous for this taxpayer unless his
state tax deduction is reduced to about $11K. Suppose the
original numbers were changed such that the state tax
deduction taken was $11K, and the refund was $2K. Then only
$400 (20%) of the refund would be taxable, since the rest of
it would have been disallowed as part of the limitation.

In 2006, the limitation amounts (either 3% of AGI or 80% of
affected deductions) are reduced by one-third.

-Mark Bole

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- quote -

But the limitation is based on total income, so it would be
$9K even if the state income tax were lower.

Seth

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parrisbraeside[at]yahoo.ca wrote:
- quote -

No, that is not correct. See Chapter 29 of Pub 17. The
following are subject to limitation: taxes, interest paid,
gifts to charity, most miscellaneous deductions. So the
$45K that was allowed did NOT include the full amount of the
state and local tax deduction, the $9K that was disallowed
DID include some of it.

Therefore the amount of the refund will most likely only be
partly taxable in the following year. It's not simple or
straightforward. Please re-read the previous replies (some
of which are also wrong).

-Mark Bole

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"Gil Faver" <rowdy'sb...[at]xxyz.com> wrote:

- quote -

Because you were allowed $45,000 in itemized deduction and
there state tax credit in the itemized deductions was
$45,000. They just disallowed the other 9,000.

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"Gil Faver" <rowdy'sb...[at]xxyz.com> wrote:

- quote -

Because you were allowed $45,000 in itemized deduction and
there state tax credit in the itemized deductions was
$45,000. They just disallowed the other 9,000.

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Gil Faver wrote:

- quote -

Yes, also true for about a half-dozen other situations where
no prior-year tax benefit was derived. I like the one where
your prior year AMT liability means you didn't get any
benefit, but if you continue to have a sizable AMT liability
in the current year, it doesn't matter, since state taxes
are an AMT exclusion item anyway. But it's still probably
worth it to get your AGI right, due to the many indirect
effects of that number.

- quote -

Correct -- both the 1040 instructions and Pub 525 indicate
that the simple worksheet does not cover the special cases.
Try Worksheet 2 in Pub 525 and the accompanying discussion
there.

I'm not surprised if tax software (not your question, but
relevant) does not always cover every single scenario, after
all what's the marketplace cost/benefit to doing so?

-Mark Bole

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- quote -

You're right. The State and Local Income Tax Refund
Worksheet does not take into account the itemized deduction
limitation. That's why you can't use that worksheet if your
itemized deductions were limited in the previous year.
Exception 9 in the instructions above the worksheet in the
1040 instructions tells you this in a very complicated way.

See the section on Recoveries in IRS Publication 525, and
particularly the topic "Itemized deductions limited"
beginning at the bottom of page 24 (of the 2006 edition).
There is no worksheet for this situation. To calculate the
amount that has to be reported as income you have to follow
the instructions in the text at the bottom of page 25.

Bob Sandler

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"Gil Faver" <rowdy'sboss[at]xxyz.com> wrote:

- quote -

First of all, please do not confuse logic or common sense
with tax simplification.

You have to allocate the disallowed itemized deductions to
the various categories of itemized deductions claimed in the
previous years. Determining just how much benefit the state
& local tax deduction may require reruning the tax return
several times with different sets of numbers to find out how
much of the state & local tax deduction actually provided a
benefit. The IRS may have a publication on topic.

___________________________________
<<< Benjamin Yazersky, CPA [NJ & NY] > > -----> real address on hobokeni or hobokenx <-----

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"Gil Faver" <rowdy'sb...[at]xxyz.com> wrote:

- quote -

Because you didn't do it right.

Try this shortened form:

Itemized deductions actually taken: $54,000
Greated of itemized deductions if only actual state tax
had been deducted, or standard deduction: $41,000
Tax Benefit: $13,000 ($54,000 - $41,000)
Taxable state refund: $13,000

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I can run the worksheets, with a bit of effort, but the
result does not seem to match the premise.

As I understand the premise, a tax refund is taxable to the
extent it provided a tax benefit in a prior year. So it
seems that to the extent the tax was not used to provide a
tax benefit due to limitations on Schedule A itemized
deductions, the tax refund should not be treated as income
when it is received in a subsequent year.

However, the State and Local Tax Refund Worksheet does not
seem to take into account the extent to which a tax was not
allowed to be used as a Schedule A deduction.

Here's an example (simplified, may not work precisely with
IRS worksheet):

Prior year total deductions: $54,000
(taxes=$45k; other=$9k)
prior year allowed deductions: $45,000
disallowed deductions due to limitation: $9,000
this year's tax refund: $13,000

amount of this years tax refund that is taxable: $13,000

why is it not, at most, say $4k?

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