2017 State Tax Refunds Federally Taxable in 2018!!!

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High Technology
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2017 State Tax Refunds Federally Taxable in 2018!!!

Post by High Technology » Sat Jan 12, 2019 8:41 am

Holy Shoot -- if I've got this right, this is another KICK IN THE TEETH for high tax states (I live in NY).

I just started doing an estimate of my 2018 tax return using H&R Block software that I've used for years. In 2017 I paid a significant amount of state taxes, and also paid AMT. In the past, since I paid AMT each year, any state tax refund wasn't deemed taxable to me since the IRS forms had logic that figured out if you effectively took the deduction for them.

This year, I know state taxes are limited to $10k, and I would have expected that there would similar logic on the taxable nature of 2017 state tax refunds received in 2018, or this year's tax deduction for SALT would be applied to the "net" of my taxes paid this year (i.e., less any refunds received).

Based on what the H&R Block program is showing, THIS IS NOT THE CASE. I received a $8,700 refund last year, and it is coming up as federally taxable for 2018. My state taxes paid/withheld this year are way over $10k, and I know I can only take the standard deduction.

This makes no sense whatsoever. Had I know this would be the treatment, instead of a refund last year, I would have elected to apply the over-payment to my 2018 state taxes. Then I would have paid/withheld less this year, and wouldn't be taxed on the $8,700 over-payment in 2017.

TBillT
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by TBillT » Sat Jan 12, 2019 9:54 am

Sorry.
I am confused if this is any differernt than the past. The state tax refund will nomally be taxed if you over-deducted the prior year.

I also have about $2500 refund as I over-paid state last year.

You are luckier than Virginian's in one way, that NY apparently now allows you to itemize state even if you cannot itemize Federal. Virginia is is not making that move (so far) which means many will have to itemize Federal even if they are below the Standard Deduction, so they can itemize state.

The Wizard
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by The Wizard » Sat Jan 12, 2019 10:02 am

$8700 seems like quite a large state income tax overpayment and refund...
Attempted new signature...

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Chief_Engineer
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by Chief_Engineer » Sat Jan 12, 2019 10:02 am

I believe this is how itemizing state taxes paid has always worked. The next year any state tax refund is taxable because you deducted more than you actually paid in state taxes. As far as I understand this was unchanged in the new tax law.

simas
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by simas » Sat Jan 12, 2019 10:05 am

Similarly confused - this was always that way. if you overpaid state taxes (and subtracted them from your federal income), the refund is taxable and was always so.

" Had I know this would be the treatment, instead of a refund last year, I would have elected to apply the over-payment to my 2018 state taxes. Then I would have paid/withheld less this year, and wouldn't be taxed on the $8,700 over-payment in 2017."

from federal income tax it would have worked the same way- zero difference. if you have applied them to 2018 state income taxes then you would have paid less in 2018 in state income taxes and therefore subtracted less from federal and increased your federal by the very same amount of 8700. whether it went to your first and back to state or stayed with the state, from federal tax liability it would not have made a difference between these years.

stan1
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by stan1 » Sat Jan 12, 2019 10:09 am

The Wizard wrote:
Sat Jan 12, 2019 10:02 am
$8700 seems like quite a large state income tax overpayment and refund...
It is, but it happened to me last year because I made a large, unexpected DAF contribution the last week of December in response to tax law changes.

I don't know enough about AMT to be able to answer OP's question. He might be in a gotcha situation since he paid AMT in 2017 but presumably not 2018. It is still early; there could be a bug in his tax software (I found one in Turbo Tax for Roth IRA conversions that got fixed in mid-December).

Longdog
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by Longdog » Sat Jan 12, 2019 10:13 am

I agree that this doesn't sound right. The determination for whether a state tax refund for tax year 2017 (refunded in 2018) is Federally taxable in 2018 should be the same as it was for 2017. In other words, if it wasn't actually deducted in 2017 then it shouldn't be treated as taxable in 2018. In 2019, state tax refunds for tax year 2018 (refunded in 2019) would go by the new rules for itemized deductions and AMT.

In H&R Block, there is a question when you enter a tax refund asking how much of it is taxable. Might you have overlooked that?
Steve

MarkNYC
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by MarkNYC » Sat Jan 12, 2019 1:13 pm

The amount of state tax you deduct in 2018 is not relevant to how much of your 2018 state tax refund is taxable.

Generally, with some rare exceptions, if AMT applied in the prior year, then some or all of the state refund is nontaxable. In most cases where AMT exists the full refund is nontaxable. In some situations, where the refund is large and AMT relatively small, a portion of the refund that was deducted in the prior year provided a tax benefit and is therefore taxable; the remaining portion did not provide a benefit and is nontaxable. Without seeing your tax return, my guess would be that the latter situation applies to you. The problem is that many tax programs cannot do the calculation correctly, and by default treat the full state tax refund as taxable if the amount deducted provided ANY tax benefit in the prior year, which is not correct.

In order to determine the correct taxable amount, the taxpayer would need to go back to the prior year return, and probably through trial and error, adjust the state tax deduction amount to determine how much of the refunded taxes that were deducted actually provided a tax benefit before AMT kicked in. Using the marginal tax rate as a shortcut usually doesn't give a correct result.

In my experience, the IRS tax return program is also unable to determine in this situation how much of the refund should be taxable.

Good Listener
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by Good Listener » Sat Jan 12, 2019 5:37 pm

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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by Artsdoctor » Sat Jan 12, 2019 5:55 pm

stan1 wrote:
Sat Jan 12, 2019 10:09 am
The Wizard wrote:
Sat Jan 12, 2019 10:02 am
$8700 seems like quite a large state income tax overpayment and refund...
It is, but it happened to me last year because I made a large, unexpected DAF contribution the last week of December in response to tax law changes.

I don't know enough about AMT to be able to answer OP's question. He might be in a gotcha situation since he paid AMT in 2017 but presumably not 2018. It is still early; there could be a bug in his tax software (I found one in Turbo Tax for Roth IRA conversions that got fixed in mid-December).
If he paid AMT in 2017, he did not receive any deduction for the state tax and is not subject to being taxed on the refund in 2018.

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FiveK
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by FiveK » Sat Jan 12, 2019 7:12 pm

High Technology wrote:
Sat Jan 12, 2019 8:41 am
This makes no sense whatsoever.
Correct. Probable user error. ;)

Take a second look, as suggested by several.

Katietsu
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by Katietsu » Sat Jan 12, 2019 7:23 pm

My experience with various tax software is that they assume the refund is entirely taxable UNLESS you indicate that some of it is not. Then they take you to a new worksheet or set of questions to determine how much is taxable.

The best analogy I can think of is that the software assumes that all of a Roth conversion is taxable unless you indicate somewhere that there where non deductible contributions.

NotWhoYouThink
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by NotWhoYouThink » Sat Jan 12, 2019 7:34 pm

MarkNYC wrote:
Sat Jan 12, 2019 1:13 pm
The amount of state tax you deduct in 2018 is not relevant to how much of your 2018 state tax refund is taxable.

Generally, with some rare exceptions, if AMT applied in the prior year, then some or all of the state refund is nontaxable. In most cases where AMT exists the full refund is nontaxable. In some situations, where the refund is large and AMT relatively small, a portion of the refund that was deducted in the prior year provided a tax benefit and is therefore taxable; the remaining portion did not provide a benefit and is nontaxable. Without seeing your tax return, my guess would be that the latter situation applies to you. The problem is that many tax programs cannot do the calculation correctly, and by default treat the full state tax refund as taxable if the amount deducted provided ANY tax benefit in the prior year, which is not correct.

In order to determine the correct taxable amount, the taxpayer would need to go back to the prior year return, and probably through trial and error, adjust the state tax deduction amount to determine how much of the refunded taxes that were deducted actually provided a tax benefit before AMT kicked in. Using the marginal tax rate as a shortcut usually doesn't give a correct result.

In my experience, the IRS tax return program is also unable to determine in this situation how much of the refund should be taxable.
This is the right analysis.

In past years I have had to go back to the previous year tax program and figure out how much the overpayment affected my prior year taxes, and what amount of the overpayment/refund was taxable in the next year. It isn't as simple as taxsplaining that "well, since you paid AMT you got no federal tax benefit from your state tax payments so none of it is taxable", it turns out that if you had paid less state tax you might have avoided AMT, so you have to go back and do the math.

So great news, you get a stimulating intellectual exercise to figure out how much, if any, of the refund should be taxed.

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High Technology
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by High Technology » Sat Jan 12, 2019 8:04 pm

I will check again, but in the past several years I have paid AMT every year -- most year's $10k or more. My RE taxes alone are over $30K (nearly 4% of my home's value in suburban NYC -- yes, I live in a particularly high RE tax area that I can't wait to get out of 5 years from now when my kids are all out of the schools), and state taxes are also high in NY -- especially for those at my income level.

In the past, it was AMT all the way, so the net effect was that my state taxes paid were not deductible, but my refund was effectively not taxed (since that is excluded for AMT). Now that the AMT ceiling has been lifted, it's not the same situation since the refund is taxable for regular tax purposes (it's not that I didn't technically itemize last year, but due to AMT eliminating the deduction is the same net effect). So I am effectively being taxed on $8700 that I paid to NY in 2017 that I didn't actually get a tax benefit from). Hopefully this is a one-year anomaly since I am now taking the same standard deduction as most others (and thus my state tax refund shouldn't be taxable in the future).

If you are wondering how such a large state tax refund happens, NY (similar to NJ if I recall) has a dumb withholding rule for bonus (and other non-periodic income) that is even higher than the normal max rate -- NY is 9.62%. My job has a high percentage of non-base pay, so every year they end up over-withholding NY State by a $5k give or take and since I usually owe Federal by a similar amount, it's not so much out of pocket. I usually file mid-Feb and have the IRS debit my checking account in early April (about when my NY refund arrives), so the cashflow is a bit of a wash...

And, no, I really don't benefit from the reduced tax rates. People living in high state and local tax areas are in many cases paying more. Without this hiccup, I was expecting to see perhaps a $1k reduction (like many others making say $100K, which is admittedly way less than I make). I'm fine not getting a bigger break even though I pay more, but I don't want to pay more under the new law when most others are getting a decent break. If the $8700 is now taxed at 35% (yes my taxable income gets me into that bracket), that leaves me paying about $2k more than the prior law (even with AMT under the old law).

I get it -- most will think I'm highly paid, so I should just "suck it up", but I really am peeved because everyone thinks the higher paid people got this major windfall and should pay more. I'm not Warren Buffet (though I admire his long-term investment style), but when you look at people's effective tax rates the upper middle class in high cost areas who are primarily paid on W-2's (and thus basically get little/no deductions with a $10k SALT limit) they are in many cases paying MORE under the new law.

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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by Artsdoctor » Sat Jan 12, 2019 8:21 pm

^ Strictly speaking, NowWhat is right. There is a formula for those subject to the AMT getting a state tax refund and how it is taxed. TurboTax could do that for you in the past, and it would most likely be able to do it for you this year although I've not tried it. Practically speaking, it would be relatively rare to be subject to the AMT, get the state tax refund, and to have to pay back a portion the following year. As I mentioned, I have played with TurboTax in the past to do it and it was absurdly complex, initially because I wanted to see what my accountant was talking about. I would NOT rely on TurboTax to ultimately tell you if you are subject to taxes on the refund, though, unless they have really made the program more obvious.

Addendum: I just played around with TurboTax and it should be able to calculate your exclusion correctly, although you'll have a lot of fun plugging all of the data in. Go to Schedule 1, Line 10, and then go to the state refund tax worksheet. You're interested in the Recovery Exclusion and you can put all of your data in, but you'll need your 2017 return. It's cumbersome but you can work through it if you're not using an accountant, although you'll spend a lot of time doing it.
Last edited by Artsdoctor on Sat Jan 12, 2019 8:29 pm, edited 1 time in total.

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FiveK
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by FiveK » Sat Jan 12, 2019 8:28 pm

High Technology wrote:
Sat Jan 12, 2019 8:04 pm
In the past, it was AMT all the way, so the net effect was that my state taxes paid were not deductible, but my refund was effectively not taxed (since that is excluded for AMT).
And that remains true - it is last year's treatment of your state tax deduction for AMT purposes that determines this year's treatment of the refund as taxable or not.
Now that the AMT ceiling has been lifted, it's not the same situation since the refund is taxable for regular tax purposes (it's not that I didn't technically itemize last year, but due to AMT eliminating the deduction is the same net effect). So I am effectively being taxed on $8700 that I paid to NY in 2017 that I didn't actually get a tax benefit from).
It is the same situation. If your state tax payments in 2017 did not affect your 2017 federal taxes, your state tax refund in 2018 is not federally taxable.

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High Technology
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by High Technology » Sat Jan 12, 2019 9:08 pm

Thanks, all. I'll dig into H&R Block to see if I can get it to exclude it in a legit way.

While I've used H&R Block's software in the past, I also have access to TurboTax (I got a freebie from Fidelity, so I planned to parallel the two this year given the change in the tax law). I know in the past the H&R Block software doesn't do a few things automatically, such as the AMT carryover which has one entry that (for whatever reason) doesn't actually get carried over from the prior year.

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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by jain27 » Tue Feb 12, 2019 8:50 pm

NotWhoYouThink wrote:
Sat Jan 12, 2019 7:34 pm
MarkNYC wrote:
Sat Jan 12, 2019 1:13 pm
The amount of state tax you deduct in 2018 is not relevant to how much of your 2018 state tax refund is taxable.

Generally, with some rare exceptions, if AMT applied in the prior year, then some or all of the state refund is nontaxable. In most cases where AMT exists the full refund is nontaxable. In some situations, where the refund is large and AMT relatively small, a portion of the refund that was deducted in the prior year provided a tax benefit and is therefore taxable; the remaining portion did not provide a benefit and is nontaxable. Without seeing your tax return, my guess would be that the latter situation applies to you. The problem is that many tax programs cannot do the calculation correctly, and by default treat the full state tax refund as taxable if the amount deducted provided ANY tax benefit in the prior year, which is not correct.

In order to determine the correct taxable amount, the taxpayer would need to go back to the prior year return, and probably through trial and error, adjust the state tax deduction amount to determine how much of the refunded taxes that were deducted actually provided a tax benefit before AMT kicked in. Using the marginal tax rate as a shortcut usually doesn't give a correct result.

In my experience, the IRS tax return program is also unable to determine in this situation how much of the refund should be taxable.
This is the right analysis.

In past years I have had to go back to the previous year tax program and figure out how much the overpayment affected my prior year taxes, and what amount of the overpayment/refund was taxable in the next year. It isn't as simple as taxsplaining that "well, since you paid AMT you got no federal tax benefit from your state tax payments so none of it is taxable", it turns out that if you had paid less state tax you might have avoided AMT, so you have to go back and do the math.

So great news, you get a stimulating intellectual exercise to figure out how much, if any, of the refund should be taxed.
Thank you for explanation. Where do I enter this information? 1099-G form has full amount but where should I report taxable amount of state tax refund>

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FiveK
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by FiveK » Tue Feb 12, 2019 10:16 pm

jain27 wrote:
Tue Feb 12, 2019 8:50 pm
where should I report taxable amount of state tax refund>
Line 10 of Schedule 1.

mega317
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by mega317 » Tue Feb 12, 2019 11:57 pm

My experience with TurboTax (web version (I have a chromebook)) on this was they asked yes or no, do I want to refigure my 2017 return. Got a warning like it will take a lot of time and math but might save you money. Then they had me do it by hand. It did take a little while but wasn't really a big deal. Clearly worth the principle alone and for me it was a few hundred bucks.

I didn't use any numbers that weren't on the 2017 return so I don't know why TT couldn't just do it.

986racer
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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by 986racer » Wed Feb 13, 2019 12:35 am

mega317 wrote:
Tue Feb 12, 2019 11:57 pm
My experience with TurboTax (web version (I have a chromebook)) on this was they asked yes or no, do I want to refigure my 2017 return. Got a warning like it will take a lot of time and math but might save you money. Then they had me do it by hand. It did take a little while but wasn't really a big deal. Clearly worth the principle alone and for me it was a few hundred bucks.

I didn't use any numbers that weren't on the 2017 return so I don't know why TT couldn't just do it.
I got the same warning from TurboTax. Not sure what their definition of "a lot of time" is, but it took about 10 minutes. It saved me about $3500 this year. I wish I could annualize that.

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Re: 2017 State Tax Refunds Federally Taxable in 2018!!!

Post by TimeRunner » Wed Feb 13, 2019 9:04 am

986racer wrote:
Wed Feb 13, 2019 12:35 am
I got the same warning from TurboTax. Not sure what their definition of "a lot of time" is, but it took about 10 minutes. It saved me about $3500 this year. I wish I could annualize that.
I did that too and saved just under $500. Well worth the time to fire up last year's TurboTax and key some numbers in on a copy of last year's tax return.
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