Taxable refunds of state and local taxes - electing standard deduction to avoid?

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e5116
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Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by e5116 » Wed Feb 06, 2019 10:41 pm

So, I noticed that when I filled out my taxes this year, it auto-populated my state tax refund from 2017 taxes as taxable income for the 2018 year. Okay, fine.

My question is that if I'm expecting another decent sized state refund THIS year, it seems like I can avoid the above scenario for NEXT year if I choose the standard deduction instead of itemizing, right? If I itemize deductions, I am at $24,180 whereas the standard deduction for MFJ is $24,000. So, it's very close, but I think "losing" the $180 in deductions will be a net positive by next year because I'll then avoid having to declare $800+ as income for next year. Am I thinking about this right? Sounds kinda wacky to me.

lstone19
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by lstone19 » Wed Feb 06, 2019 11:14 pm

A refund of state income tax is taxable only to the extent that you received a benefit. Given how you wrote this, I am assuming you were not limited by the $10k SALT limitation in which case, with $24,180 in itemized deductions, only the first $180 of a state income tax refund will be taxable (if you are limited by the $10k SALT limitation, then possibly none of it is taxable). Next year, refigure your 2018 deductions as if the refund amount was never paid in the first place (if it drops you below $24k, switch to the standard deduction). The difference is the taxable amount of the refund.

spectec
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by spectec » Thu Feb 07, 2019 8:44 am

If the numbers are close, and especially if you are limited by the SALT deduction, in many cases it is better to elect to use the Sales Tax tables in lieu of the state income tax deduction. Electing the Sales Tax deduction completely eliminates the need to jump through the hoops to calculate any amount to be puled back into income in the following year. (This applies in situations where itemizing still yields a greater benefit than the standard deduction, even after calculating the SALT limit).
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. - Will Rogers

Topic Author
e5116
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by e5116 » Thu Feb 07, 2019 12:39 pm

spectec wrote:
Thu Feb 07, 2019 8:44 am
If the numbers are close, and especially if you are limited by the SALT deduction, in many cases it is better to elect to use the Sales Tax tables in lieu of the state income tax deduction. Electing the Sales Tax deduction completely eliminates the need to jump through the hoops to calculate any amount to be puled back into income in the following year. (This applies in situations where itemizing still yields a greater benefit than the standard deduction, even after calculating the SALT limit).
Wow, did not realize you can do that. That's pretty cool. Yes, I'm severely limited by the SALT deduction. But because I prepaid property taxes in 2017, this method ever so slightly hurts me this year (reduces my refund by $40) -- it would have helped or been neutral had I paid all my property taxes within 2018. If I choose standard deduction instead (with state income tax deduction), I am $3 better off apparently.

So, obviously, I don't care about the $3 either way, but sounds like I'm 100% safe that state refund won't count as income next year if I choose either 1) sales tax deduction OR 2) the std deduction (because choosing the sales tax deduction essentially defaults me to the std deduction, so it's really the same thing)? It's the unknown of "how much the refund is taxable for next year." I'm not sure how to calculate that. This year, looks like all of it is taxable based on my math. If it's the $180 or whatever, it's probably a wash with the $40 difference more I'll owe this year.

That is, any of the three methods would yield similar results over the two year timeframe. But to be safe, I'm probably going to just choose the std deduction. I'm clearly overthinking this. :D

spectec
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by spectec » Fri Feb 08, 2019 4:48 pm

Anyone paying property taxes in the range of roughly $7,000 - 9,000 should take a look at this option if they are itemizing. There are a number of variables involved in calculating the sales tax deduction figure (income, family size, state of residence), but it's just a matter of looking up the figure on a table. It's worth doing the math in order to avoid having to calculate the tax benefit of the state tax refund in the following year.
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. - Will Rogers

Topic Author
e5116
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by e5116 » Sun Feb 10, 2019 2:38 pm

spectec wrote:
Fri Feb 08, 2019 4:48 pm
Anyone paying property taxes in the range of roughly $7,000 - 9,000 should take a look at this option if they are itemizing. There are a number of variables involved in calculating the sales tax deduction figure (income, family size, state of residence), but it's just a matter of looking up the figure on a table. It's worth doing the math in order to avoid having to calculate the tax benefit of the state tax refund in the following year.
Thanks spectec, I appreciate your knowledge and taking the time to respond. Normally, my property taxes are north of $12k/year, but last year was the exception because I pre-paid them given the tax law change, so there were less than $6k. WIth all the said, I'm still not clear what my best path forward is. Here's the summary:
  • Option #1: Itemize: Fed refund is $110, State refund is about $1350
    *Option #2: Take std deduction: Fed refund is $63, State refund stays the same at $1350
    *Option #3: Select sales tax deduction: Fed refund is $63, state refund stays the same at $1350
Clearly, option #1 is best for this year, but then some (or all) of that state refund will be taxable next year. If all, then at a 24% bracket, that will cost me $324, which doesn't seem right as only the amount taxable should be the benefit I received, but not sure what that is. Thoughts? Should I just do option #2 to not worry about it even though I lose ~$50 of refund for this year?

lstone19
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by lstone19 » Sun Feb 10, 2019 3:25 pm

e5116 wrote:
Sun Feb 10, 2019 2:38 pm
Thanks spectec, I appreciate your knowledge and taking the time to respond. Normally, my property taxes are north of $12k/year, but last year was the exception because I pre-paid them given the tax law change, so there were less than $6k. WIth all the said, I'm still not clear what my best path forward is. Here's the summary:
  • Option #1: Itemize: Fed refund is $110, State refund is about $1350
    *Option #2: Take std deduction: Fed refund is $63, State refund stays the same at $1350
    *Option #3: Select sales tax deduction: Fed refund is $63, state refund stays the same at $1350
Clearly, option #1 is best for this year, but then some (or all) of that state refund will be taxable next year. If all, then at a 24% bracket, that will cost me $324, which doesn't seem right as only the amount taxable should be the benefit I received, but not sure what that is. Thoughts? Should I just do option #2 to not worry about it even though I lose ~$50 of refund for this year?
Your three options, as listed, are a little confusing. I assume option 1 is itemize and use state income tax and option 3 is itemize and use sales tax deduction.

Take a look at your Schedule A. Line 5d is your SALT before the $10k limit. To the extent it's over $10k, you're not getting a benefit. So if line 5d is $11,000, the first $1,000 of your state refund provided no benefit so only $350 would be taxable. Figure out how much of your state refund will be taxable and go from there. Since option 2 and option 3 give the same federal refund, it appears the sales tax deduction is giving no benefit so whatever you're using is going with the standard deduction. Assuming same marginal bracket for 2018 and 2019, taking the deduction now and having part of the refund taxable should be a wash (it should increase next year's tax by that $47 difference (ignoring any rounding issues that might result)) except you have use of the money for a year.

kaneohe
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by kaneohe » Sun Feb 10, 2019 3:35 pm

https://www.irs.gov/pub/irs-pdf/i1040gi.pdf
see the wksht on p. 88 of the 1040 instructions for Sch1 line 10 for the real answer.

boomer_techie
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by boomer_techie » Sun Feb 10, 2019 3:36 pm

e5116 wrote:
Sun Feb 10, 2019 2:38 pm
  • Option #1: Itemize: Fed refund is $110, State refund is about $1350
    *Option #2: Take std deduction: Fed refund is $63, State refund stays the same at $1350
    *Option #3: Select sales tax deduction: Fed refund is $63, state refund stays the same at $1350
It looks like the deduction in Option #3 isn't high enough to exceed the standard deduction, hence the software is just doing a standard deduction. So - nix this option.
Clearly, option #1 is best for this year, but then some (or all) of that state refund will be taxable next year.
You need to find what amount of state tax deduction yields the $63 refund. In the absence of understanding the formula involved, you can do this via Newtonian Approximation. Example with made up numbers: Claim a $1000 deduction -> refund is $100. Claim a $500 deduction -> refund is $30. Claim a $700 deduction -> refund is $60. Claim a $740 deduction -> refund is $70. Claim a $720 deduction -> refund is $64. And so on until you get the exact number.

Then, only the portion of the deduction beyond the magic number is taxed. You implied you are in the 24% bracket. The likely amount of state deduction that is taxable is (110-63)/(24%), i.e. $195.83.

lstone19
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by lstone19 » Sun Feb 10, 2019 3:39 pm

kaneohe wrote:
Sun Feb 10, 2019 3:35 pm
https://www.irs.gov/pub/irs-pdf/i1040gi.pdf
see the wksht on p. 88 of the 1040 instructions for Sch1 line 10 for the real answer.
Those instructions and the related worksheet are for refunds in 2018 of state and local income taxes paid in 2017 before the $10k SALT limitation existed. I would expect next year's instructions and worksheet (particularly the worksheet) to be significantly different.

boomer_techie
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by boomer_techie » Sun Feb 10, 2019 3:42 pm

kaneohe wrote:
Sun Feb 10, 2019 3:35 pm
https://www.irs.gov/pub/irs-pdf/i1040gi.pdf
see the wksht on p. 88 of the 1040 instructions for Sch1 line 10 for the real answer.
Yup! But the OP needs the 2019 Form 1040 version of that worksheet.

kaneohe
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by kaneohe » Sun Feb 10, 2019 3:55 pm

yes, you two are really on the ball! Agree w/ boomer technies iteration method for guessing at the taxable amount which should be easy if using software.

Topic Author
e5116
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by e5116 » Sun Feb 10, 2019 4:09 pm

Thank you kaneohe, boomer_techie, lstone19 for the additional information and expertise. I truly appreciate this site and those willing to help provide information just for the sake of educating others. Thanks! :beer

spectec
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by spectec » Sun Feb 10, 2019 4:19 pm

With only $6K of property taxes, I''m not clear on how the other figures play out. It seems the state income tax deduction would have more effect on the results on an itemized return. But if these figures are correct, I'd opt to take the standard deduction. The benefits of leaving $57 on the table are that everything is wrapped up nice & tight, nothing carries forward to next year, and there's virtually no audit risk associated with the return. That has value.
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. - Will Rogers

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Epsilon Delta
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by Epsilon Delta » Sun Feb 10, 2019 4:35 pm

lstone19 wrote:
Sun Feb 10, 2019 3:25 pm
Assuming same marginal bracket for 2018 and 2019, taking the deduction now and having part of the refund taxable should be a wash (it should increase next year's tax by that $47 difference (ignoring any rounding issues that might result)) except you have use of the money for a year.
Except that the taxable refund adds to AGI next year while the deduction did not reduce AGI this year. Even if you're in the same bracket if there are AGI based items such as taxation of SS benefits or ACA premium credits the marginal rate may be higher so it's not a wash. Quite possible the effective APR on the loan is usurious.

lstone19
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by lstone19 » Sun Feb 10, 2019 6:36 pm

Epsilon Delta wrote:
Sun Feb 10, 2019 4:35 pm
Except that the taxable refund adds to AGI next year while the deduction did not reduce AGI this year. Even if you're in the same bracket if there are AGI based items such as taxation of SS benefits or ACA premium credits the marginal rate may be higher so it's not a wash. Quite possible the effective APR on the loan is usurious.
Good point. Those are not issues for me so did not think about them.

ryman554
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Re: Taxable refunds of state and local taxes - electing standard deduction to avoid?

Post by ryman554 » Mon Feb 11, 2019 10:32 am

e5116 wrote:
Sun Feb 10, 2019 2:38 pm
spectec wrote:
Fri Feb 08, 2019 4:48 pm
Anyone paying property taxes in the range of roughly $7,000 - 9,000 should take a look at this option if they are itemizing. There are a number of variables involved in calculating the sales tax deduction figure (income, family size, state of residence), but it's just a matter of looking up the figure on a table. It's worth doing the math in order to avoid having to calculate the tax benefit of the state tax refund in the following year.
Thanks spectec, I appreciate your knowledge and taking the time to respond. Normally, my property taxes are north of $12k/year, but last year was the exception because I pre-paid them given the tax law change, so there were less than $6k. WIth all the said, I'm still not clear what my best path forward is. Here's the summary:
  • Option #1: Itemize: Fed refund is $110, State refund is about $1350
    *Option #2: Take std deduction: Fed refund is $63, State refund stays the same at $1350
    *Option #3: Select sales tax deduction: Fed refund is $63, state refund stays the same at $1350
Clearly, option #1 is best for this year, but then some (or all) of that state refund will be taxable next year. If all, then at a 24% bracket, that will cost me $324, which doesn't seem right as only the amount taxable should be the benefit I received, but not sure what that is. Thoughts? Should I just do option #2 to not worry about it even though I lose ~$50 of refund for this year?
It will not cost you $324. You got $47 om benefits out of the state tax deduction. Since you refund >> $47 (number should be $47/state effective tax rate), you will end up owing $47 extra in taxes next year, give or take.

Look at it this way, if you redid your taxes assuming your state taxes were less by $1350, you will end up in option #2 -- there is likely no advantage to itemizing. OR you will end up in option #1 if you are over your 10k SALT limit (new this year, but I dealt with AMT similar issues in years past). If the former, you basically have to reaccount for the real state taxes, and end up paying the equivalent of $47 in tax. If the latter, then you end up owing $0 extra, since the state refund did not affect your taxes one way or another.

The intent of the form is to adjust your state taxes to accurately reflect what the deduction should have been (just like how owing the state money gets added onto the next years state tax burden) and get the "correct" deduction.

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