overpaid state income tax itemized into federal deductions. any way to fix this year instead of next year?

Question

When overpaid state income tax is itemized into the federal deduction, I get back federal money I'm not technically entitled to. Next year I will have to report the state refund and pay federal taxes on it.

1) Will I have to report the 2006 state refund only if I itemize on the 2007 tax return? If yes, great (though doesn't make much sense), if not, where will it be reported?

2) Is there a way to adjust my federal taxes this year so that I don't get back this federal money now and don't have to report state refund next year? If yes, how? I was hoping for something on Schedule A, but I don't see it.

Thanks.

Ok I see the answer to #1 -- it's like 10 on the 1040. Thanks, Bill.

But why would I have to amend my return? I haven't filed it yet. I will know exactly what all the amounts are before I file, I just don't know how to adjust my itemized deductions.

crazydave -- your answer to my #2 doesn't apply because if I receive a refund for 2006 taxes, I have to report it on my 2007 tax return. Withholding won't change that. And no, I don't need to adjust anything -- this year is a special case and I didn't know I'll itemize until November.

The actual problem is that I plan to be in a higher tax bracket in 2007, so if I have to pay tax on my refund I will simply lose a small chunk of money.

skip -- yes, it's legitimate, and not just for 2006, it's also for 2007. I think people are having a hard time reading the years in my question, but they are correct, you just need to pay attention -- I refer to the 2006 tax return as the one due April 15 2007, and the 2007 tax return as the one due April 15 2008.

You said that "The clawback is to the extent of the tax benefit received." But according to my estimates it is not. Example -- if my state refund is $100, then I will save $25 this year (because that $100 is part of itemized deductions under "state taxes paid"), but I will pay $28 next year.(because the refund will be reported on the tax return as income).

It's too late to adjust anything for this year, and there won't be any need next year.

I am going to itemize, there's no question about it. I just want to itemize in such a way that my state tax refund is included in the federal calculation. Generally federal is calculated first, then propagated to the state forms. I need the info on the state form to make it back to federal. I want to pay the proper federal tax with my 2006 return, not with my 2007 return.

Clarification for Judy -- 12% interest (~ 28/25) is a little too high, especially considering that I know all this in advance. There's gotta be a way to fix it, does no one know....

Answer 1

Let me get this right - you're doing some sophisticated, legitimate planning for 2006? Sorry, but that is a bit unusual for anyone posting here, so it took me by surprise.

Have you considered the state sales tax deduction? This especially applies if you bought a new car (or boat or plane) in 2006. Sales tax is not subject to clawback, unless you get a refund of sales tax paid in the year. That is, most likely, only going to happen if you return the car in 2007 for a refund.

More plausibly, how much over the Standard Deduction are you? If not by much, there may be some value in claiming that instead.

Whatever you choose, there are three calculations you have to do and they must be done based on the figures you have.

Just to clarify, you report a refund for a particular year only if you itemized in that year. The theory is that you claimed too many deductions for that year so the IRS wants to claw it back. The clawback is to the extent of the tax benefit received so it cannot go any lower than the higher of (a) itemized deductions as if sales tax was claimed instead and (b) the standard deduction for that year.

If you think about it, adjusting withholdings can help. You anticipate being in a higher tax bracket in 2007 than in 2006. You could adjust withholdings for your last paycheck in 2006 so that you eliminate the refund. of course, that means you will pay less state tax and get a smaller deduction in 2006. It also means that you do not have to recognize income from a refund in 2007. Effectively, what you are doing is shifting income from a higher-tax year (2007) to a lower-tax year (2006).

Edit: OK, you are going to itemize in 2006 and you cannot adjust withholdings, so the only question is whether you claim state sales tax or income tax deduction. It comes down to the number-crunching. In most cases, the income tax deduction is better. The question is: what puts more money in your pocket? Remember, if you take the sales tax you do not need to report your income tax refund at all. Even if you do take the income tax deduction, you only report the income in 2007 to the extent that it exceeds what you could have claimed in 2006 had you used the sales tax. That, of course, may be a moot point.

Further Edit: You cannot do what you propose (deducting the refund due to be received from this year's deduction). I think you are trying too hard with this one. Some (many!) tax situations cannot be resolved to the taxpayer's liking. Sorry!

Answer 2

Individual taxpayers are on a cash basis, so you don't have a choice on reporting the entire amount paid for 2006, then reporting the refund on line 10 of your 1040 for 2007, whether you itemize or not for 2007.

You're right, if you're in a higher bracket for 2007 than for 2006, it will unfortunately cost you a little extra in taxes. Think of the extra as "interest" you got for having the extra refund for a year.

Answer 3

No, the standard procedure is to report the state tax refund on the front of the 1040 (it has its own spot on the form).

The only workaround would be to amend your Federal return with a 1040X and adjust the deduction for total accuracy...far too much work.

Answer 4

If you can't add, subtract, multiply and divide why did your high school award you a diploma? Why did your state allow you to pass the standardized exams? Accounting usually only requires low levels of math and higher problem solving skills. Your excuses are ignorant and do not have common sense involved. What is so hard about 55,000 x 7.5% - 5,600 ? so they passed the threshold by $1,475. The minimum is 55,000 x 7.5% or 4,125, so anything beyond that beats the threshold tests. I think you don't understand what it is your flaws truly are. TRO - really ? Textbooks generally do not use the current tables, they also tend to mix up and confuse you on purpose by using various tax years and dates in problems. She never said which tax year the teacher gave her. It is not a true taxpayer question. It is an academic homework question.

Answer 5

1) Yes. There is a spot on page 1 of Form 1040
2) To avoid reporting the state refund, adjust your state withholding to receive little or no refund.