 Income tax 2021-2022. Taxable refund credits or offset of state and local income taxes. Get ready to get refunds to the max, diving into income tax 2021-2022. Here we are in our income tax formula, still looking at line one, the income line. This is the first page of the form 1040. We're no longer looking at those items that are just directly on the form 1040, possibly with a supplemental schedule like a schedule B, but now we're on line eight, which is pulling from another schedule entirely that's coming from the other income from schedule one. So we gotta go to schedule one. Here's schedule one, part one. We're looking at number one, which is the tax refunds, credits, or offsets of state and local income taxes, which then feeds in and pulls over to the first page of the 1040 on line eight. So let's just get a general overview of these refunds. This can be a point of confusion because when you think about a refund, you might say, well, why would a refund be taxable? And when you talk about the federal refund on the federal taxes, then it's not something that's gonna be taxable and that makes sense because of course, if you are getting a refund for an overpayment, so in other words, if I overpaid my taxes during the tax year of 2021, and remember how the tax return works, basically they wanna get paid during the year of 2021, not the point in time that you file, that's why we try to overpay in order to get a refund when we file by April 18th in this case of 2022, so that we can avoid penalties and interest. So it wouldn't make sense that if they're giving us a refund because we overpaid the taxes, that then we have to include that as income in the following year, say 2022, because we got a refund. It's not really a refund in that instance. It was an overpayment that we, if it's not income in that instance, it was a refund or an overpayment, so we shouldn't have to record it as income. So that's on the federal side, but if you're talking about state taxes, it's possible that we might be able to get a tax benefit on the federal side from the state and local taxes. So in other words, if I got to deduct a state taxes, let's take for example, California, which is a high tax area, it's likely then a lot of people got a state tax deduction to benefit their federal taxes. A whole situation that I think is a mess and they never should have started in the first place because it leads to a cause, a lot of kind of problems in terms of the influence of the Fed and the state, but let's say that you got a deduction on the schedule, A is what would typically be for the state taxes. And let's say that you overpaid the state taxes, well, if you got a big state tax deduction and you overpaid it, and then they paid you the refund back the following year, now you got a deduction on the federal side for taxes that you didn't actually pay because you didn't pay those taxes. So for example, in tax year 2020, if I had state taxes were only 1,000 and I paid 5,000 of state taxes and then I deducted 5,000 of my state taxes as itemized deductions, then I would have got a benefit of 5,000 state tax deduction, but then they gave me a refund in 2021 of 4,000. So now I got 4,000 back and I really only paid 1,000, but I deducted in the prior year the full $5,000 amount. Well, that's when you would have to say, okay, that's not fair, you gotta record it. There's two things you could do at that point. You could say I need you to amend your tax return for 2020 so that you can report the proper 1,000 instead of what you actually paid of the 5,000 because you got the refund, but no one wants to amend the tax return. So what you do is basically report that amount as income in the following year when you get the refund and in this case, we'd say 2021. So if you're looking at this, the general rule then would be the refund is gonna be common. Most people are gonna get a refund. The question is, do you have to record the refund as income? And for a lot of people that's gonna be no because they didn't get a tax benefit from it in the prior year, you would only get a tax benefit from it in the prior year if instead of taking the standard deduction, you itemize deductions that would generally only happen if you had itemized deductions over the standard, normally happening for people that have like a home, for example, because they're taking the state local taxes, the property taxes and the mortgage interest and possibly people that are in a higher income tax or cost of living place. And then those are the people that might then have got a tax benefit from the deduction. And that's when you'd have to then record it as income. That's also confusing because you will get like a 1099 which is an indication that you might have to record something as income. But in this case, you gotta be wary of that. You gotta be able to see that you may not record it. Now, if you have tax software, the tax software is gonna help you because if you perform the tax software over from the prior year to the current year, then the software is gonna know how much of the deduction was a benefit from the prior year and help you to determine whether the refund is gonna be taxable in the current year. But a lot of times when people do the data input, they try to put something into this spot right here and they say, that's where it should go. I put it in the data input and it's not showing up here. That's because the software is thinking that there wasn't a benefit from the prior year so it's not included in the current year. And again, that causes a lot of confusion for people when they're doing the data input. We'll take a look at that in the next presentation with the software. That's the general idea, the general rule. So taxable refunds, credits or offset of state and local income taxes, none of your refund is taxable if the year you pay the tax, you either didn't itemize the deductions. So if you didn't itemize, you didn't get a benefit from the state tax deduction because it's an itemized deduction. So if someone didn't itemize in the prior year, then tax refund they got in the current year is not something that you have to record an income or be elected to deduct state and local general sales tax instead of state and local income taxes. So if you're in a state, for example, that doesn't collect their taxes primarily through an income tax, but rather through a sales tax, then obviously they didn't get an income tax refund from the state because it's not the same kind of scenario. If you're in an area like California that has a substantial income tax on the state, then they itemized and it's more likely that you'd have to include an income. If you received a refund, credit or offset of state or local income taxes in 2021, you may be required to report this amount. If you didn't receive a Form 1099G, check with the government agency that made the payment to you. Your 2021 Form 1099G may have been made available to you only in an electronic format and you will need to get instructions from the agency to retrieve this document, report any taxable refund you received even if you don't receive the Form 1099G. Now, it should be fairly straightforward what your tax refund would be because you'll have your taxes from the prior year and if nothing changed, you know what your refund is from the prior year, but you should get the tax form with it as well. If you choose to apply a part or all of the refund to your 2021 estimated state or local income tax, the amount applied is treated as received in 2021. So in other words, if in 2020, you had a refund come into you and you said, instead of mailing me a check, I want you just to apply that as a payment that's going towards my 2021 taxes, which is often what people might do if they were like self-employed, for example, they don't have withholdings from their W-2 income, but they're applying the actual refund to the next payment that they're gonna make. Well, that still means that you got a refund. It's kind of like you got the money and then you gave it back to the IRS. So you still got the refund and then paid it back. It's just that they didn't go through that process. So if the refund was taxable, it would still be taxable in that case, even though you didn't actually get it, but applied it over to the next year. If the refund was for a tax you paid in 2020 and you deducted state and local income taxes on your 2021 schedule A, use the state and local income tax refund worksheet and these instructions to see if any of your refund is taxable. So if it is taxable, it gets a little bit more confusing than you would think. You might say, well, if they itemized and they got a refund, then I'm just gonna include it as taxable. But it might be the case that not all of the refund was taxable because there's a cap on how much state taxes that you can deduct and you might have only got so much of a benefit over basically what you would have gotten in the standard deduction. So it actually gets a little bit confusing when it becomes taxable and it's really nice to have tax software to help you out with that kind of calculation. Usually it would be best if you had the software in the prior year and then in the current year. So in other words, even if you're picking up a new client and those instances where they have itemized deductions, it might be beneficial for you to take the prior year tax return and enter it into the prior system so that calculations like this and any other rollover calculations will be done by the software for you a lot more clearly, generally. So the more complex the tax return is for a new client. In other words, you might wanna enter the prior tax return into your system and then roll it over, perform it over so that any kind of rollovers in these kind of calculations will be done for you. See itemized deduction recoveries in publication 525 instead of using the state and local income tax refund worksheet in these instructions if any of the following apply. One, you've received a refund in 2021 that is for a tax year other than 2020. So that would be a different, more unusual type of scenario. Possibly you filed your tax returns late or something like that and you're getting a refund in 2021 for something other than the prior year. Two, you received a refund other than an income tax refund such as a general sales tax or real property tax refund in 2021 of an amount deducted or claimed in an earlier year. So it's something other than that's again a bit different of a scenario. So now you're getting the refund from property taxes which is more unusual or sales tax. And if you got the deduction of those items in the prior year and now you're getting a refund from them, you're in a similar kind of situation where it seems like you kind of over deducted. And so some action might be needed to be taken at that point at that point. So three, you have taxable income on your 2020 form 1040 or 1040 SR line 15 but no tax on your form 1040 or 1040 SR line 16 because of the zero tax rate on the net capital gain and qualified dividends in certain situations. And four, your 2020 state and local income tax refund is more than your 2020 state and local income tax deduction minus the amount you could have deducted as your 2020 state and local general sales tax. So in other words, what's the actual benefit you're getting from the deduction for it? So you got to figure out your, just because you had an itemized deduction doesn't mean that you got the full benefit of the sales tax. You got to figure out what the actual kind of benefit was that you got in the itemized deduction and that's the portion that you generally would have to include in income. In the current year five, you made your last payment of 2020 estimated state or local income tax in 2021. So now the last payment that you made was made in 2021 and we're on a cash basis when we're talking about these deductions for the state and local taxes. So in 2020 in this instance, for example, if you had a W-2 employee then all of the withholdings would have been made in the current tax year. So if we're talking about the prior year 2020, all the withholdings would have been made by December 31st, 2020. But if you pay quarterly like a Schedule C type of business, then it's possible that your last quarter payment for tax year 2020 was made in tax year 2021, January of 2021. So when you're thinking about deductions in terms then because that payment was made on a cash payment basis in 2021, you would think that it would be something that would be deducted in the 2021 tax year even though it's being applied to 2020. So in other words, on the federal side, it would be deducted in 2021. You wouldn't have included it as a deduction in the prior year of 2020. So that cutoff can be a little bit confusing. So six, you owed alternative minimum tax in 2027. You couldn't use the full amount of the credits you were entitled to in 2020 because the total credits were more than the amount shown on your 2020 form 1040 or 1040 SR line 16. Eight, you could be claimed as a dependent by someone else in 2029. You received a refund because of jointly filed return or local income tax return, but you aren't filing a joint 2021 form 1040 or 1040 SR with the same person. So again, some of these can get a little bit confusing when you start to look at the items that could be taxable and the taxable amount of the refund could be quite nice to have the software to help you out with that. Even if it's a new client, you can basically do that by saying, could I please have your prior year tax return, put it into the prior year software, take the extra time to do that for more complex returns, roll it over, and then the software will help you out with some of these calculations for rollover items and the amount of state tax might be deductible for more complex returns.