 Income tax 2022-2023, taxable refunds, credits, or offsets of state and local income taxes, tax software example. Let's do some wealth preservation with some tax preparation. Support Accounting Instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Here we are in our example, Form 1040, populated with LASERT tax software. You don't need tax software to follow along, but it's a great tool to run scenarios with. You can also get access to the Form 1040 related schedules and forms at the IRS website, irs.gov, irs.gov. The starting point we typically start at is going to be that single filer, Mr. Anderson, no dependents, 100,000, even W2 income. And then we've got the 12,950 standard deduction getting us down to the 87,050 for the taxable income, mirroring that on our tax worksheet in a formula format, 100,000, 12,950 standard deduction, 87,050, depending on the software then. To do the calculation, page two, 14,774. So that's going to be here and then we imagine 15,000 that was withheld getting us to the 226. Now our major objective is looking at page one, the calculation of the income. Now thinking about and imagining, we got a Form 1099, usually a form indicating that we might have to include something in income, a 1099G. That's going to be indicating that we got a refund from the state. Now again, this is an unusual form to think about as income because it's like, well, wait a second. It's a refund of me overpaying, meaning, for example, if you thought about it on the federal side of things, if I overpaid my taxes for the federal income taxes in 2021 and got a refund, it's not like I'm going to include that in income in 2022. It was an overpayment that now they're compensating for. It's a refund. So why would I have to include a refund on the tax return on the state side of things? So a couple of things just to kind of get the groundwork now that we're looking at a form is that one, the federal income tax is different from the state taxes. A lot of people confuse those two things. The federal income tax is designed. The federal government should be separate from the duties of the state government. You have a separation of duties there. The federal government's primary goal is to keep us safe having a military. Military. Exactly. That's designed to do that. That's the general objective, the primary objective of the federal government. The states then are supposed to be taking care of their state needs, including all the state obligations like the police and whatnot on the state level. So the federal government uses a federal income tax, which is of course what we're focused in on here. The states, however, should have their own sovereignty to tax however they want. They don't have to mirror the fed government. And in fact, having different states tax in different ways is our testing ground. It allows us to see which tax systems are working out better and worse. We can actually look at them and say, okay, what is this actually doing? So, but then you have this kind of kind of convolution between the federal and the state, meaning we're able to deduct some of the state taxes on the federal tax return sometimes. Now, I think this was if we can design the tax from scratch again, then I wouldn't include this. I don't think this was a good idea to add, but it's one of those things that you can't really pull out or change once included because people have been making decisions based on that already. So that's what we have put in place. Now, the state tax deductions then will only be applied if they have an itemized deduction. So remember down here that we've got the bigger of the itemized or the standard deductions. We'll talk about itemized deductions later, but let's just look at the Schedule A for now to try to make sense of this income 1099G. If we go to the Schedule A, let's imagine last year in 2021, this person, Mr. Anderson, had itemized deductions. If they got a benefit from them, they would be here under the taxes you paid. Now, the taxes you paid, it used to be that it was only the income tax that you kind of got a benefit from, which obviously is a subsidy to the kinds of states that have income taxes, like California and New York, and obviously is a disincentive to states that choose to tax in another format, like a sales tax or something. So then, of course, they changed that and said, okay, now we're going to give you a deduction. Try to give you an itemized deduction, no matter what kind of tax that you on the state level determined to do to try to kind of equalize the playing field. So now you've got the state taxes that might be deductible on the federal side of things. If you're in like California, that would typically be the state income tax. So when you figure out your taxes, you, of course, in 2021, last year would be figuring out your federal taxes and also thinking about how much you paid in state taxes. If you're itemizing, you might be able to deduct on the federal tax side of things the state taxes that you're paying basically on a cash-based type system when you paid them. Now then you can imagine, of course, in 2022, just like on the federal income tax side, on the state income tax side, you might have overpaid because it's a complicated tax system. It has a progressive tax structure. So it's not going to be perfect. You will have overpaid most likely and therefore they're going to give you a refund. That refund then is the thing and that's where the question comes in. You might also get a 1099G then saying that you got the refund and that's the question, well, do you have to include it in income in 2022 when you got the refund? And you might think, well, no, why should I have to do that? It's a refund, but you got a deduction. That's where the problem is. If you got a deduction for it, then you would think that if they refunded part of it, one of two things would happen. You would have to amend the tax return for 2021 to remove the part that you got a deduction for that was refunded to you, or you can just say, okay, whatever you got refunded, I'm just going to include as income in the period I got refunded it. So that kind of makes sense, right? We're trying to correct for the fact that we might have overdiducted in the prior year by including it in income in the current year. So that's the general scenario. So the bottom line then would be, well, if you got a 1099G, then you want to look at the prior year tax return. If this was a new client, for example, and you're not rolling over the software for the prior year, you have a copy of the prior year return, hopefully, and you can say, well, did they do an itemized? Is there a schedule A in the prior year? If there's not a schedule A, then you're probably not going to, it's not going to be included in income, right? Because there's no schedule A in the prior year. They didn't get a benefit. That's pretty straightforward. If there is a schedule A in the prior year, then it gets more messy because they may have gotten a benefit. Plus benefits. From the payment, but there's exceptions, right? Because the question is, well, how much of a benefit did they get from that portion of the refund? And that's where it gets messy, and that's when the software comes in to be helpful. So for example, if you've got that form, you might then say, okay, let's jump on over to the schedule one. Here's the tax refunds. So if I just jump on over there and go to my 1099G and say this was a state refund, state refund, and I say that this is going to be state and local tax refund, and let's say I got whatever $1,000 refunded, and I just plug that in. If I jump back on over, that might not populate here. It's not populating. Why? Because the software doesn't know if I got a benefit from it last year. It doesn't know if I got a benefit. This often confuses people because they say, well, if I got a 1099G and I entered it in the proper area on the tax return, it should pull over. Well, the software is saying, well, I don't know if it should pull over because I can't tell if you got a benefit from it in the prior year. Now, if you're using the same software from last year to the current year, then hopefully the software will be able to know whether or not you got a benefit, and it'll help you out with that calculation. If you have a new client, then you can basically say, well, if it's an easy tax return, I can see that they didn't itemize last year, so I'm not going to go through the problem of entering the data into the 2021 tax return and rolling over. I'm just going to say, yeah, I entered that in and it didn't pull over. That makes sense because they didn't have a benefit last year anyways, so no problem. No problem. However, if I look at the last year tax return and they did itemize, they have these itemized deductions that are greater than the standard deduction, I would suggest that instead of just starting that new client entering it into 2022 tax software, you might think about entering it into 2021, which is more costly maybe because maybe you have to pay for a 2021 return in order to populate it, but it might be worthwhile to do and then rolling it over to 2022, so the software can then do some of these calculations automatically as you roll the information forward. So I'm going to imagine, let's imagine last year that they did itemize. Let's imagine, for example, let's mirror it this time. What are the things that usually pull people over to itemizing? We'll talk about this more later, but they're going to be, if I go to the itemized deduction, if they own a home, if they own a home, then they might have interest on the home, home mortgage interest. So let's add the home mortgage interest, and we'll talk more about these later, but let's just say it was significant, like 20,000 in the home mortgage interest, and let's say their taxes were, let's say the real estate taxes were, let's say, let's say 6,000. Now then they would also have state taxes, which if you were populating, if I was doing like a California return, I would also be calculating the state taxed at the same time, and it would help me to pull out and determine that, or it'll give me the taxes that are being calculated for the sales tax using a table, or I can populate the sales tax. So now I'm going to say, okay, well, they're itemizing possibly, if I pull this on over to page one, they're over the standard deduction. So okay, oh, they're itemizing. So that would be, I would think, then it's much more likely that that state refund would have to be included in income, which would look something like this. So now I've got the state tax refund included here, and on schedule one, and if I pull that back on over to the 1040, now I've got the 100,000 here, and then I've got the 1,000 pulling in from the taxable income, and then we've got our itemized deductions. Now we're at the 73, 983, and so on. So notice I basically made an override forcing the 1,000 to pull in on the software here. Again, in practice, I would think the best theory, the best practice to do is if you have an easy tax return, one in which they didn't have a schedule A last year, then you could maybe just start your tax return in 2022 and just go forward. If you have a more complex tax return, and so for example, if someone had a schedule A, I would typically do the practice of putting that and mirroring the same data input for that new client in 2021 tax year to match what the data input was so I can then roll it over to 2022, allowing the software to help me with some of those worksheets to determine if they got a benefit from things like the state taxes and other kind of rollover kind of components. That might cost more to do that, but that gets you off on the right foot, I think from the first year going forward. So I think that's worthwhile to do oftentimes for more complex tax returns, because again, you could imagine, like if they itemized last year, you might say, well yeah, they got a benefit from it because they've got this taxes that they deducted here on the schedule A, but remember if the taxes are high enough, let's imagine the state taxes are like 12,000, let's say, and then I pull this over, now there's gonna be a cap of 10,000. So now there's a cap. So now there's a question of well yeah, the amount that refunded may not have impacted the amount I got a benefit from because there's a cap of 10,000 on it. Or you can imagine a situation where I'm just barely getting over the itemized threshold, right? So if I could have gotten a standard deduction of in this case 12,950, and then I just barely got over to itemizing because my itemized deductions including the state taxes happened to be $13,000, well then I didn't really get a benefit, I only got a benefit of like $50 added. So if my state tax refund or the state tax deduction was like $2,000 or whatever, I really only got a benefit of it of like $50, right? You could see where these problems come into play and how it can be a complicated worksheet to actually drill down on how much benefits you got. So what you want to have an idea is the general theory and then use the software and see that the software and double check deconstruct what the software is doing. If the software then calculates and says, well only half of the tax is being included in schedule one. As long as you didn't overwrite it, then you can say okay, does that make sense and deconstruct it? Why does that make sense? Well yeah, because they hit the cap on the schedule A last year. So that means that some of the state taxes, they didn't get a benefit from the deduction and whatnot. That's the general idea of the thought process that you might think through when you get that form 1099G. The basic thing that you would tell the client would be, I got a 1099G, do I have to include it in income? Or they might ask, you might do the tax return and they say, hey look, I got a 1099G and you didn't include it in income, you should have because I got a 1099G and your response is, well no, you're only going to include it there if you got a benefit from it last year and if you didn't itemize, you didn't get a benefit. The only reason they gave you a 1099G is because they don't know if you got a benefit from it or not and that's the reason it wouldn't be there if it wasn't there or something like that, right?