2019 Tax Question with respect to 2018 SALT deduction limit

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hrc84
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2019 Tax Question with respect to 2018 SALT deduction limit

Post by hrc84 » Thu Feb 14, 2019 7:36 am

Does anyone know how the tax liability for a 2018 state refund will work for 2019 tax year's return if you itemized taxes in 2018, but you hit the $10000 SALT deduction limit in 2018? Is there any IRS publication on this scenario?

Thanks

livesoft
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by livesoft » Thu Feb 14, 2019 7:59 am

One can simply run a scenario in 2018 tax prep software. Just tell the tax prep software about fictitious 2017 state income tax refund and see what happens.
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hrc84
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by hrc84 » Thu Feb 14, 2019 8:14 am

livesoft wrote:
Thu Feb 14, 2019 7:59 am
One can simply run a scenario in 2018 tax prep software. Just tell the tax prep software about fictitious 2017 state income tax refund and see what happens.
So the limit on how much of the state taxes could be deducted which is new to 2018, i.e. not applicable to 2017, has no effect?

MikeG62
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by MikeG62 » Thu Feb 14, 2019 8:16 am

hrc84 wrote:
Thu Feb 14, 2019 7:36 am
Does anyone know how the tax liability for a 2018 state refund will work for 2019 tax year's return if you itemized taxes in 2018, but you hit the $10000 SALT deduction limit in 2018? Is there any IRS publication on this scenario?

Thanks
I have seen nothing authoritative on this (does not mean it does not exist though). I personally tend to think the tax law (or interpretation of it by the IRS) will lean in favor of that which provides more tax revenue to the government.
Real Knowledge Comes Only From Experience

Userdc
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by Userdc » Thu Feb 14, 2019 8:18 am

I’m way above the SALT limit, so I’m assuming state tax refunds will no longer be included in income starting with my 2019 return.

livesoft
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by livesoft » Thu Feb 14, 2019 8:30 am

hrc84 wrote:
Thu Feb 14, 2019 8:14 am
livesoft wrote:
Thu Feb 14, 2019 7:59 am
One can simply run a scenario in 2018 tax prep software. Just tell the tax prep software about fictitious 2017 state income tax refund and see what happens.
So the limit on how much of the state taxes could be deducted which is new to 2018, i.e. not applicable to 2017, has no effect?
I didn't run the scenario, so I don't know. I asked you to run the scenario with your 2018 tax prep software. What was the result?
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hrc84
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by hrc84 » Thu Feb 14, 2019 8:36 am

livesoft wrote:
Thu Feb 14, 2019 8:30 am
hrc84 wrote:
Thu Feb 14, 2019 8:14 am
livesoft wrote:
Thu Feb 14, 2019 7:59 am
One can simply run a scenario in 2018 tax prep software. Just tell the tax prep software about fictitious 2017 state income tax refund and see what happens.
So the limit on how much of the state taxes could be deducted which is new to 2018, i.e. not applicable to 2017, has no effect?
I didn't run the scenario, so I don't know. I asked you to run the scenario with your 2018 tax prep software. What was the result?
Can you better explain to me how this is not a new scenario to 2019 tax preparation? I don't see the point in simulating something that to my knowledge couldn't occur prior to next year tax's filling.

Longdog
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by Longdog » Thu Feb 14, 2019 8:38 am

This was at least partially discussed in viewtopic.php?f=2&t=271368:
Steve

jebmke
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by jebmke » Thu Feb 14, 2019 8:42 am

The general rule has been, a state tax refund is only reportable to the extent that you benefited from a deduction of the state income taxes in the prior year. I have never seen any indication that they intend to change that interpretation.

Of course, even if reported, the tax liability created by reporting it depends on everything else on your return.

The 1040 General Instructions and Pub 525 discuss this.

I have seen cases where, despite deducting state income tax in the prior year, 100% of the state tax refund was not reportable.
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livesoft
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by livesoft » Thu Feb 14, 2019 8:45 am

hrc84 wrote:
Thu Feb 14, 2019 8:36 am
Can you better explain to me how this is not a new scenario to 2019 tax preparation? I don't see the point in simulating something that to my knowledge couldn't occur prior to next year tax's filling.
1. Fill out your 2018 tax return with tax prep software. Presumably SALT-limit is the law in your 2018 tax prep software.

2. Make a copy of the tax return file created by the tax prep software.

3. Open the copy of the 2018 tax return file in the 2018 tax prep software and give yourself a big state tax refund. That is, tell the 2018 tax prep software about a fictitious 1099-G that you didn't actually get. Make sure to tell the 2018 tax prep software about only the amounts deducted on your 2018 tax prep software in #1 (the original one, not the copy).

4. Tell me what happened.
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hrc84
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by hrc84 » Thu Feb 14, 2019 8:48 am

MikeG62 wrote:
Thu Feb 14, 2019 8:16 am
hrc84 wrote:
Thu Feb 14, 2019 7:36 am
Does anyone know how the tax liability for a 2018 state refund will work for 2019 tax year's return if you itemized taxes in 2018, but you hit the $10000 SALT deduction limit in 2018? Is there any IRS publication on this scenario?

Thanks
I have seen nothing authoritative on this (does not mean it does not exist though). I personally tend to think the tax law (or interpretation of it by the IRS) will lean in favor of that which provides more tax revenue to the government.
Userdc wrote:
Thu Feb 14, 2019 8:18 am
I’m way above the SALT limit, so I’m assuming state tax refunds will no longer be included in income starting with my 2019 return.
These two statements are at odds in my opinion, which I think shows there is confusion in this area.

In my personal situation for 2018, it slightly (not much over 24000) makes the most sense to itemize my federal return. But my concern is that if I am taxed fully on my 2018 state refund (sizable) when completing my 2019 federal return due to itemizing on my 2018 federal return, I might be better not itemizing in 2018 to exempt my 2018 state refund from 2019 federal taxes.

MikeG62
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by MikeG62 » Thu Feb 14, 2019 8:54 am

jebmke wrote:
Thu Feb 14, 2019 8:42 am
The general rule has been, a state tax refund is only reportable to the extent that you benefited from a deduction of the state income taxes in the prior year. I have never seen any indication that they intend to change that interpretation.
So if you had state and local taxes (income + property) well in excess of $10,000 and enough other itemized deductions that when coupled with the $10,000 SALT deduction causes you to itemize, who is to say that the IRS will not conclude that the first component of your $10,000 SALT deduction is not your state income taxes (making any refund of such in the following year taxable)? While the taxpayer might argue that the SALT deduction was made up mostly or entirely of their property taxes, the IRS might argue the opposite (as it would be in their interest to do so).

So unless I am missing something (which is possible) it seems that unless and until the IRS weighs in on this, it is not clear what the result will be in 2019 in the OP's assumed scenario.
Real Knowledge Comes Only From Experience

cherijoh
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by cherijoh » Thu Feb 14, 2019 9:00 am

hrc84 wrote:
Thu Feb 14, 2019 7:36 am
Does anyone know how the tax liability for a 2018 state refund will work for 2019 tax year's return if you itemized taxes in 2018, but you hit the $10000 SALT deduction limit in 2018? Is there any IRS publication on this scenario?

Thanks
Is this the scenario you are asking about?
  • You overpaid the state taxes you are owed for 2018, but you didn't fully get to deduct all your state and local taxes because of the SALT cap.
  • You had enough other itemized deductions (e.g., mortgage interest, charitable deductions, etc.) for itemizing to still make sense.
By how much would you expect your SALT deductions to be capped relative to your excess state income taxes?

IIRC, before NC changed their income tax forms a few years ago, they had you compare the amount your itemized deductions exceeded the IRS standard deduction and the amount you had included on Schedule A for state and local taxes. They had you add back in the smaller of those two figures to calculate NC taxable income.

Perhaps the IRS will handle it the same way - i.e., only the part of the excess state income taxes that contributed to your itemized deduction would be taxable income in the following year.

Longdog
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by Longdog » Thu Feb 14, 2019 9:06 am

MikeG62 wrote:
Thu Feb 14, 2019 8:54 am
jebmke wrote:
Thu Feb 14, 2019 8:42 am
The general rule has been, a state tax refund is only reportable to the extent that you benefited from a deduction of the state income taxes in the prior year. I have never seen any indication that they intend to change that interpretation.
So if you had state and local taxes (income + property) well in excess of $10,000 and enough other itemized deductions that when coupled with the $10,000 SALT deduction causes you to itemize, who is to say that the IRS will not conclude that the first component of your $10,000 SALT deduction is not your state income taxes (making any refund of such in the following year taxable)? While the taxpayer might argue that the SALT deduction was made up mostly or entirely of their property taxes, the IRS might argue the opposite (as it would be in their interest to do so).

So unless I am missing something (which is possible) it seems that unless and until the IRS weighs in on this, it is not clear what the result will be in 2019 in the OP's assumed scenario.
I expect that there will be a worksheet of some sort that has you add last year's state income tax + local income tax + property tax - state income tax refund - local income tax refund, and if that number is still greater than or equal to $10K, any refund is not taxable in the following year. If that number is below $10K, then the amount that is taxable in the following year will be the difference between what was claimed for the SALT portion of your itemized deductions in the previous year and the result of that calculation.
Steve

MikeG62
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by MikeG62 » Thu Feb 14, 2019 9:27 am

Longdog wrote:
Thu Feb 14, 2019 9:06 am
MikeG62 wrote:
Thu Feb 14, 2019 8:54 am
jebmke wrote:
Thu Feb 14, 2019 8:42 am
The general rule has been, a state tax refund is only reportable to the extent that you benefited from a deduction of the state income taxes in the prior year. I have never seen any indication that they intend to change that interpretation.
So if you had state and local taxes (income + property) well in excess of $10,000 and enough other itemized deductions that when coupled with the $10,000 SALT deduction causes you to itemize, who is to say that the IRS will not conclude that the first component of your $10,000 SALT deduction is not your state income taxes (making any refund of such in the following year taxable)? While the taxpayer might argue that the SALT deduction was made up mostly or entirely of their property taxes, the IRS might argue the opposite (as it would be in their interest to do so).

So unless I am missing something (which is possible) it seems that unless and until the IRS weighs in on this, it is not clear what the result will be in 2019 in the OP's assumed scenario.
I expect that there will be a worksheet of some sort that has you add last year's state income tax + local income tax + property tax - state income tax refund - local income tax refund, and if that number is still greater than or equal to $10K, any refund is not taxable in the following year. If that number is below $10K, then the amount that is taxable in the following year will be the difference between what was claimed for the SALT portion of your itemized deductions in the previous year and the result of that calculation.
Let me use some numbers to ensure I get what you are saying. Assume the following (single taxpayer):

State and local taxes paid in 2018 $8,000
Property Taxes paid in 2018 $8,000
Mortgage Interest paid in 2018 $10,000
2019 refund of overpaid 2018 state and local income taxes $2,000

So itemized deduction would be $20,000 in 2018.

What you are saying is that none of this $2,000 refund would be taxable because the sum total of the 2018 S&L + property taxes ($20,000) less the $2,000 refund in received in 2019 of $18,000 is still in excess of the $10,000 cap?

Ok Longdog, I buy that. Makes sense to me.
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Topic Author
hrc84
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by hrc84 » Thu Feb 14, 2019 10:11 am

MikeG62 wrote:
Thu Feb 14, 2019 9:27 am
Longdog wrote:
Thu Feb 14, 2019 9:06 am
MikeG62 wrote:
Thu Feb 14, 2019 8:54 am
jebmke wrote:
Thu Feb 14, 2019 8:42 am
The general rule has been, a state tax refund is only reportable to the extent that you benefited from a deduction of the state income taxes in the prior year. I have never seen any indication that they intend to change that interpretation.
So if you had state and local taxes (income + property) well in excess of $10,000 and enough other itemized deductions that when coupled with the $10,000 SALT deduction causes you to itemize, who is to say that the IRS will not conclude that the first component of your $10,000 SALT deduction is not your state income taxes (making any refund of such in the following year taxable)? While the taxpayer might argue that the SALT deduction was made up mostly or entirely of their property taxes, the IRS might argue the opposite (as it would be in their interest to do so).

So unless I am missing something (which is possible) it seems that unless and until the IRS weighs in on this, it is not clear what the result will be in 2019 in the OP's assumed scenario.
I expect that there will be a worksheet of some sort that has you add last year's state income tax + local income tax + property tax - state income tax refund - local income tax refund, and if that number is still greater than or equal to $10K, any refund is not taxable in the following year. If that number is below $10K, then the amount that is taxable in the following year will be the difference between what was claimed for the SALT portion of your itemized deductions in the previous year and the result of that calculation.
Let me use some numbers to ensure I get what you are saying. Assume the following (single taxpayer):

State and local taxes paid in 2018 $8,000
Property Taxes paid in 2018 $8,000
Mortgage Interest paid in 2018 $10,000
2019 refund of overpaid 2018 state and local income taxes $2,000

So itemized deduction would be $20,000 in 2018.

What you are saying is that none of this $2,000 refund would be taxable because the sum total of the 2018 S&L + property taxes ($20,000) less the $2,000 refund in received in 2019 of $18,000 is still in excess of the $10,000 cap?

Ok Longdog, I buy that. Makes sense to me.
Longdog's expectation makes sense to me, but I am unaware of it being backed up by an IRS ruling.

Let me throw out another hypothetical situation.

MFJ

State and local taxes paid in 2018 $7500
Property taxes paid in 2018 $5000
Mortgage Interest and Donations in 2018 $14500
Refund of overpaid 2018 state and local income taxes $1500

Itemized deduction would be $10000 SALT limit + $14500 = $24500 in 2018.

Longdog's proposed solution $12500 - $1500= $11000 which is equal or in excess of $10000 so no tax liability on the $1500 state refund on 2019 taxes.

Another (reasonable?) approach where prorate occurs, $7500+$5000 = $12500. $7500/$12500 * 100 = 60% has no tax liability on 2019 taxes, but 40% of refund is liable which is $600.

This $600 is greater than the $24500 itemized - $24000 standard deduction = $500 reduced tax liability realized on 2018 taxes. So would it have made more sense to not itemize on 2018 return where there is a $500 deduction to not realize an increased 2019 return tax liability of $600?

ofckrupke
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by ofckrupke » Thu Feb 14, 2019 11:37 am

There is no prorating involved. In this process, you're just trying to determine whether some or all of the overpayment, that you expect to recover by refund in 2019, does not produce an incremental benefit wrt your 2018 federal tax burden.

In the case immediately above, the last $2500 of state income tax paid in 2018 does not produce a benefit (because of the SALT cap), so up to $2500 of state refund in 2019 will not be federally taxable.

I admit that the SALT cap introduces a (new?) twist though; modifying the case above to one in which the actual 2018 state/local tax liability is strictly less than $4500, only that part 2018-paid in the interval $4500 to $5000 produces a federal tax benefit in 2018 (below $4500, one would have taken the federal standard deduction; above $5000, the SALT cap completely eliminates incremental benefit). Does this mean that in such a situation, the taxable portion of the 2019-received refund (recall $7500 was 2018-paid) should be capped at $500?
Previously, the standard-itemize breakpoint and the onset of nonzero AMT were typically separated by tens of thousands of dollars in SALT; as a result, in actual practice it was typically only necessary to identify and demonstrate one of these kinks through recalculation to (establish|quantify) the (non|partial) taxability of a state refund.

Topic Author
hrc84
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by hrc84 » Thu Feb 14, 2019 1:27 pm

ofckrupke wrote:
Thu Feb 14, 2019 11:37 am
There is no prorating involved. In this process, you're just trying to determine whether some or all of the overpayment, that you expect to recover by refund in 2019, does not produce an incremental benefit wrt your 2018 federal tax burden.

In the case immediately above, the last $2500 of state income tax paid in 2018 does not produce a benefit (because of the SALT cap), so up to $2500 of state refund in 2019 will not be federally taxable.

I admit that the SALT cap introduces a (new?) twist though; modifying the case above to one in which the actual 2018 state/local tax liability is strictly less than $4500, only that part 2018-paid in the interval $4500 to $5000 produces a federal tax benefit in 2018 (below $4500, one would have taken the federal standard deduction; above $5000, the SALT cap completely eliminates incremental benefit). Does this mean that in such a situation, the taxable portion of the 2019-received refund (recall $7500 was 2018-paid) should be capped at $500?
I understand longdog's example had no pro-rating, but as far as I can tell it is a guess as to how it will be implemented. I was only throwing out another possibility with how it could be treated.

I am not sure I fully understand your question with respect to how you modified the example and the assumption on how the refund is taxed.

trueblueky
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Re: 2019 Tax Question with respect to 2018 SALT deduction limit

Post by trueblueky » Thu Feb 14, 2019 2:09 pm

MikeG62 wrote:
Thu Feb 14, 2019 9:27 am
Longdog wrote:
Thu Feb 14, 2019 9:06 am
MikeG62 wrote:
Thu Feb 14, 2019 8:54 am
jebmke wrote:
Thu Feb 14, 2019 8:42 am
The general rule has been, a state tax refund is only reportable to the extent that you benefited from a deduction of the state income taxes in the prior year. I have never seen any indication that they intend to change that interpretation.
So if you had state and local taxes (income + property) well in excess of $10,000 and enough other itemized deductions that when coupled with the $10,000 SALT deduction causes you to itemize, who is to say that the IRS will not conclude that the first component of your $10,000 SALT deduction is not your state income taxes (making any refund of such in the following year taxable)? While the taxpayer might argue that the SALT deduction was made up mostly or entirely of their property taxes, the IRS might argue the opposite (as it would be in their interest to do so).

So unless I am missing something (which is possible) it seems that unless and until the IRS weighs in on this, it is not clear what the result will be in 2019 in the OP's assumed scenario.
I expect that there will be a worksheet of some sort that has you add last year's state income tax + local income tax + property tax - state income tax refund - local income tax refund, and if that number is still greater than or equal to $10K, any refund is not taxable in the following year. If that number is below $10K, then the amount that is taxable in the following year will be the difference between what was claimed for the SALT portion of your itemized deductions in the previous year and the result of that calculation.
Let me use some numbers to ensure I get what you are saying. Assume the following (single taxpayer):

State and local taxes paid in 2018 $8,000
Property Taxes paid in 2018 $8,000
Mortgage Interest paid in 2018 $10,000
2019 refund of overpaid 2018 state and local income taxes $2,000

So itemized deduction would be $20,000 in 2018.

What you are saying is that none of this $2,000 refund would be taxable because the sum total of the 2018 S&L + property taxes ($20,000) less the $2,000 refund in received in 2019 of $18,000 is still in excess of the $10,000 cap?

Ok Longdog, I buy that. Makes sense to me.
$10,000 interest + $10,000 SALT deducted is more than the standard deduction of $12,000 single under 65. The $2000 state refund means the amount of SALT available was $16,000 instead of $18,000. Still over $10,000, so I can see that argument.

I can see proration as well. Likely not the hottest topic for IRS today. It took until January to publish final rules on QBI, so that the software was not ready the first week of February. Blame: 1) underfunded IRS, 2) really complex new section of tax law passed after no hearings on implementation, 3) five week government shutdown, 4) time required to prepare any regulations for public comment, 5) lunar cycle.

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