It's good to know that the income matching hasn't triggered an audit for you. It has for my clients, I am not saying your method is wrong, it is different from how I've seen it done. I understand what you are doing, and if it works for you-great.

The origin of this discussion was does someone need to declare their federal refund and the answer was no. If you have an alternative method that works, good for you.

-Marc
www.PDCalc.com

Marc,

I'm truly reluctant to say this but I do believe you still don't grasp the essence of what I've been saying in my posts and as the informed tax person you claim to be, it's even more disappointing.

First of all, my "method" as you call it, is nothing more than the most accurate way possible of filing a tax return. It will never lead to an audit based on any inaccuracy since it is totally and completely accurate from the get go.

Let me go through it one last time.

First of all, I complete my state tax return. This determines my state tax OBLIGATION for the year. This amount may be higher or lower than the amount of state tax withheld for the year since the amount withheld is only an approximation of what my state tax obligation will be.

Second, I complete my Federal tax return. In the space for deductions, I claim the amount of my state tax obligation, NOT the amount of state tax withheld (which, as I've mentioned, is only an approximation of my obligation).

Now, if the amount of state tax withheld turns out to be greater than my state tax obligation, then I am due a refund from the state. I DO NOT need to claim this on any Federal tax return even if I itemize since the amount I claimed as a state tax deduction (on my Federal return) is the exact amount of my state tax obligation. The refund is just the return of my overpayment from withholding.

If however, I take the easy way out and claim the amount of state tax WITHHELD as a deduction on my Federal tax return, then I have overstated my state tax deduction (assuming the state tax withheld was more than my state tax obligation) and my state tax refund must be declared on my next years Federal tax return.

Your statement in response to JLKKLJ777 which I quote below is therefore totally inaccurate.

Refund money from a state tax refund DOES NOT have to be declared on your Federal return unless you overstated your state tax deduction on your Federal return as I've said already. It has nothing to do with whether or not your return is itemized but only depends on whether or not you overstated your state tax deduction amount by using the withholding amount as opposed to the actual obligation amount.

I understand you are disappointed, now let me add to your grief.

I am citing Pub 17, which is put forth by the Internal Revenue Service.

You may check this yourself, go to the section that starts with Recoveries.

This is a bit lengthy, but if you read it, then you may understand what you to this point have not been able to grasp.

You seem to want an argument, and I won't give you one. I did not say you are wrong, what I said was you have a method that is different and I have not used that method. I understand what you are doing, but I don't understand why you come on here impuning my credentials. I am an Enrolled Agent and a Certified Financial Planner, and I have posted for you and everyone to read the relevant section from Pub 17.

Now, I will repeat what I said earlier and read what I say carefully.

Refund money from a State Refund DOES need to be declared IF you itemized AND deducted State Income taxes.

I did not go into proration of Tax or limiting the deduction, I have never done it that way, and I aknowledged that you are not wrong, just different and in my opinion may trigger an inquiry due to income matching. I stand by what I said.

Please refer to Pub 17, read it carefully, and let me know if you still have questions.

-Marc

Per Diem Reports

Publication 17 (2007), Your Federal Income Tax


Recoveries
A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). You also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.

Tax benefit rule. You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year. For more information, see Publication 525.

Federal income tax refund. Refunds of federal income taxes are not included in your income because they are never allowed as a deduction from income.

State tax refund. If you received a state or local income tax refund (or credit or offset) in 2007, you generally must include it in income if you deducted the tax in an earlier year. The payer should send Form 1099-G, Certain Government Payments, to you by January 31, 2008. The IRS also will receive a copy of the Form 1099-G. Use the State and Local Income Tax Refund worksheet in the 2007 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income. See Publication 525 for when you must use another worksheet.

After 2003, you could choose to deduct for a tax year either:
State and local income taxes, or

State and local general sales taxes.


For 2007, the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you did not choose to deduct for that year. For examples, see Publication 525.

Mortgage interest refund. If you received a refund or credit in 2007 of mortgage interest paid in an earlier year, the amount should be shown in box 3 of your Form 1098, Mortgage Interest Statement. Do not subtract the refund amount from the interest you paid in 2007. You may have to include it in your income under the rules explained in the following discussions.

Interest on recovery. Interest on any of the amounts you recover must be reported as interest income in the year received. For example, report any interest you received on state or local income tax refunds on Form 1040, line 8a.

Recovery and expense in same year. If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and is not reported as income.

Recovery for 2 or more years. If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata basis, the recovered amount between the years in which you paid it. This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of your allowable deduction for this item for the current year. For information on how to compute the allocation, see Recoveries in Publication 525.

Itemized Deduction Recoveries
If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you generally must include the full amount of the recovery in your income in the year you receive it.

Where to report. Enter your state or local income tax refund on Form 1040, line 10, and the total of all other recoveries as other income on Form 1040, line 21. You cannot use Form 1040A or Form 1040EZ.

Standard deduction limit. You generally are allowed to claim the standard deduction if you do not itemize your deductions. Only your itemized deductions that are more than your standard deduction are subject to the recovery rule (unless you are required to itemize your deductions). If your total deductions on the earlier year return were not more than your income for that year, include in your income this year the lesser of:
Your recoveries, or

The amount by which your itemized deductions exceeded the standard deduction.


Example.

For 2006, you filed a joint return. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was $10,300, and you had itemized deductions of $12,000. In 2007, you received the following recoveries for amounts deducted on your 2006 return:

Medical expenses $200
State and local income tax refund 400
Refund of mortgage interest 325
Total recoveries $925

None of the recoveries were more than the deductions taken for 2006. The difference between the state and local income tax you deducted and your local general sales tax was more than $400.

Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($12,000 − 10,300 = $1,700), so you must include your total recoveries in your income for 2007. Report the state and local income tax refund of $400 on Form 1040, line 10, and the balance of your recoveries, $525, on Form 1040, line 21.

Standard deduction for earlier years. To determine if amounts recovered in 2007 must be included in your income, you must know the standard deduction for your filing status for the year the deduction was claimed. Standard deduction amounts for 2006, 2005, and 2004, are in Publication 525.

Example.

You filed a joint return for 2006 with taxable income of $45,000. Your itemized deductions were $10,650. The standard deduction that you could have claimed was $10,300. In 2007, you recovered $2,100 of your 2006 itemized deductions. None of the recoveries were more than the actual deductions for 2006. Include $350 of the recoveries in your 2007 income. This is the smaller of your recoveries ($2,100) or the amount by which your itemized deductions were more than the standard deduction ($10,650 − 10,300 = $350).

Recovery limited to deduction. You do not include in your income any amount of your recovery that is more than the amount you deducted in the earlier year. The amount you include in your income is limited to the smaller of:
The amount deducted on Schedule A (Form 1040), or

The amount recovered.


Example.

During 2006 you paid $1,700 for medical expenses. From this amount you subtracted $1,500, which was 7.5% of your adjusted gross income. Your actual medical expense deduction was $200. In 2007, you received a $500 reimbursement from your medical insurance for your 2006 expenses. The only amount of the $500 reimbursement that must be included in your income for 2007 is $200—the amount actually deducted.

Other recoveries. See Recoveries in Publication 525 if:
You have recoveries of items other than itemized deductions, or

You received a recovery for an item for which you claimed a tax credit (other than investment credit or foreign tax credit) in a prior year.

Marc,

You seem to be unable to see the forest for the trees. Most people, when they refer to a refund, are talking about a return of an overpayment of (or excessive) withholding. If you re-read all my posts, you'll see (hopefully) that is exactly what I have been talking about. That refund of excessive withholding IS NOT a recovery unless the whole amount of withholding is used as a deduction on the Federal return. That would mean that the deduction was in error since it would be more than the actual state tax obligation. Re-read your own definition of recovery which you obtained from Publication 17. The key words to notice are "deducted" or "took credit for".

A recovery is, among other things, a refund of taxes paid. In a technical sense, you haven't paid your taxes until you've filed a return and therefore have calculated exactly what your tax is. The amount of money that's been withheld is, in a sense, held in escrow since the actual amount of your tax obligation isn't known until you file your return. A refund of excessive withholding is definitely NOT a recovery as long as you haven't included that excess as part of your state tax deduction on your itemized Federal return. As I've tried to state in all my posts, a refund only has to be claimed on Federal tax form if you claim a deduction amount larger than your actual tax obligation. I don't know how many more times I can try to say the same thing.

This year will be the 50th year I've done my own taxes (multi-state and Federal) without any questions or corrections. But then again, what do I know. As you've stated, you're the expert!

PS - By the way, you haven't added to my grief at all. I'm not the one paying for your (sometimes inaccurate) services!

Thanks for sharing.

Have a nice day.

Marc,

I truly wish you the same.

I also apologize for allowing a level of sarcasm to gradually increase in my successive responses to you. Frustration born out of feeling I wasn't being understood I guess.

I guess we'll just have to agree to disagree.