 Income tax 2023-2024, taxes you paid overview. Get ready and some coffee because we're laying down the facts about income tax preparation 2023-2024. Most of this information can be found in the instructions for Schedule A Taxure 2023 which you can find on the IRS website at irs.gov, irs.gov. Looking at the income tax formula, we're focused on what I would call the below the line deductions, more specifically the itemized deductions. Remember in the first half of the income tax formula, it's basically a funny income statement. Most income statements having income minus expenses resulting in net income here having income minus various deductions resulting in taxable income. Noting for taxes, deductions are good. Therefore, we're typically looking for more of them. The difference between the above the line deductions, adjustments to income in other words, and the below the line deductions being that the above the line deductions do not need to clear a hurdle. 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It's kind of like how in like the matrix when Neo learns kung fu or at least that's what the scientific survey saying. So get one because the scientific survey participants could really use some extra cash. If you would like a commercial free experience consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com such as that standard deduction before we get a tax benefit from them. Whereas the itemized deductions will need to be greater generally than the standard deduction before they become beneficial to us. Looking at the first page of the form 1040 line number 12 where we take the greater of the standard or itemized deductions. The itemized deductions coming from the schedule a this is the schedule a itemized deductions categories on the left hand side, although this is not the entire form. These are going to be the standard deductions that we have to keep in mind because those are the hurdles that we need to clear before we can itemized. If we are a single filer for example standard deduction we would need to clear is the 13850 double that for married 27700 head of household in the middle 20800. And if over a certain age and or blind we have increases to those standard deductions that we could see on the right hand side. If one or both of those are met single for married couples you can have one to four of those items being met with the two people. Head of household and the qualified surviving spouse and so on. Also remember the primary thing that pushes people over from taking the standard deduction to itemized deduction is the ownership of a home. Because ownership of the home typically comes with a loan a mortgage which comes with mortgage interest, which might be deductible as an itemized deduction as well as related property taxes, which are a form of state and local taxes which also could be deductible for itemized deductions. We're talking about taxes here. Taxes can be confusing because you might be thinking hey look I'm calculating the federal income tax, which is the primary tax that pays the federal government to pay for things like the military. Therefore you would think that I would not be able to deduct federal income taxes when calculating federal income taxes because that would result in a circle reference. And that's typically the case we can't really deduct federal income taxes when calculating federal income taxes. But what about state and local taxes? Are those things that can be deductible? Now remember the general rule that's often violated with the itemized deductions for an income tax would be I should be able to deduct those things that helped me to generate revenue. And we can see that most clearly on a schedule C type of business a schedule C form for a business because you have income minus expenses business deductions resulting in net income. It makes sense to tax the net income not the gross income because you needed to expend those expenditures in order to generate the revenue. However on the schedule A we often have these kind of weird things where we get to deduct things even though they're not business expenses. We saw that with the medical expenses. You can see that with like charitable deductions and whatnot. These are things that the government decided we should be able to deduct for reasons other than just the collecting of revenue to pay the military and then stay out of our business type of thing. And taxes kind of fall into that area as well on the state and local taxes. It doesn't really make sense. It kind of seems like they shouldn't be getting into deducting state and local taxes on the schedule A unless they were business type of deductions possibly. And the reason is because the federal government is kind of influencing how the states act. And you could see if you look at the past some states have been subsidized through federal taxes and they tend to increase their taxes because anything that's subsidized tends to kind of go up. So states that have high taxes you can see that happening. And they also influence the format that the states can tax. So the federal government could say they used to say will allow the state income tax as a deduction. But what if some states don't want to use an income tax they want to use a sales tax. Well then the government has to say well now we're going to include the use of a sales tax as something that we can deduct on the schedule A. And you could see how the back and forth happens and gets kind of complicated when we think about the types of things that might be deductible on the schedule A for taxes. So here's a general overview. So taxes you paid taxes you can't deduct. So federal income and most excise taxes. So clearly you can't deduct the federal income taxes for your own federal tax return that would result in a circle reference. You can't deduct Social Security Medicare federal unemployment Futa and railroad retirement RRTA. So notice that the Social Security Medicare these are Futa tax and Futa which is like a payroll tax. These are taxes that are that are kind of payroll taxes and you could say well that's not the income tax. It's separate from the income tax. Can I deduct those for federal income taxes not on the schedule A. Now if you're an employee or employee situation can you deduct the employee part of the Social Security and Medicare. That's a different issue. But if you're if you're sold if you're if you're self employed can you deduct half of the Social Security and Medicare for self employed as a schedule one deduction. Possibly that's a different issue. We're talking here though about the schedule A where you can't deduct those items. So our customs duties cannot deduct federal estate and gift taxes. Remember the estate is a whole kind of different animal meaning we typically have an income tax. We don't tax people's assets. We tax them as they are earning the money that are accumulating the assets. And then when someone dies however we kind of switch that up and we say now we're going to we're going to tax their balance sheet basically. And that's going to be an estate tax or you might hear it called like a death tax. So so that becomes a tricky you know business in and of it in and of itself where it kind of has implications on the federal income tax. But it also has a different kind of impact because it's going to be a state tax gift tax are tied into the estate tax and you could have these on the federal level as well as the as the state level. So typically not deductible. However C line 16 later if you had income and respect to a decedent. So certain state and local taxes including tax on gasoline car inspection fee assessments for sidewalks and other improvements to your property tax you paid for someone else and license fees. So let's take a look at these. These are state and local taxes so you might be saying you know these can get a little bit more confusing. So certain state and local taxes including tax on gasoline when you buy gas. There's typically a tax on the gas and the idea of the tax on the gas is the people that actually use more gas are going to be using both the roads which were community property and therefore they should be paying for more of the roads. So that would be quite tedious if we tried to calculate that and figure out how much of the gas would be would be tax and no car inspection fees assessment for sidewalks and other improvements to your property tax you paid for someone else. You can't deduct someone else's tax and license fees for example marriage drivers and pets. So if you have a marriage license and so on can't typically deduct those foreign personal or real property taxes. So we're talking state and local taxes not foreign taxes. If you have foreign income you have a whole another world of things to be looking into that's a specialty area in and of itself will which will be dependent in part on whether we have like tax treaties and what not with with the other people with the other countries. So that so that you can avoid hopefully some kind of double taxation situation. So line five the deduction for state and local taxes is generally limited to $10,000 $5,000 if filing married filing separately. This was put in place a few years ago and it was actually an attempt to I think simplify the code and be a little bit more fair and I'm someone that lives in California so I'm actually being hurt by this rule. But I think some states have kind of been taking advantage of the tax and being subsidizing subsidizing through through the tax because obviously if you have a high income individual then they're they're going to have high state taxes in places especially with high cost of living like California and New York for example and and seems that that's that's kind of subsidizing the cost of living to go up and so on in those areas. So they actually capped it at at the 10,000 so you can't take more than the 10,000 that was a controversial issue. It's clearly seems pretty clear to me that it's that that's going to be beneficial or that that that's going to hurt more wealthy individuals and it's possibly be beneficial to or not hurt at least less wealthy individuals you would think but in any case it's also a state thing so the states that have high cost of living areas obviously are arguing would argue against that and the states that are more responsible with their money frankly would say that that seems quite fair to them I would think but state and local taxes subject to this limit are the taxes that you include on lines 5a 5b and 5c so we have to keep that in consideration because again in certain states we can clear that pretty pretty easily right. So in any case safe harbor for certain charitable contributions made in exchange for a state or local tax credit. So if you made charitable contributions in exchange for a state or local tax credit and your charitable contribution deduction must be reduced as a result of receiving or expecting to receive the tax credit. You may qualify for a safe harbor that allows you to treat some or all of the disallowed charitable contribution as a payment of state and local taxes. So that's kind of a specialty area that might not come up too much but if you have more higher income tax planning situations that then you can take a look at that in more detail. The safe harbor applies if you meet the following conditions one you made a cash contribution to an entity described in section 170c two in return for the cash contribution you received a state or local tax credit three. You must reduce your charitable contribution amount by the amount of the state or local tax credit you receive if you meet these conditions and to the extent you apply the state or local tax credit. To this or a prior years state or local tax liability you may include this amount online five a five b five c whichever is appropriate. To the extent you apply a portion of the credit to offset your state or local tax liability in a subsequent year as permitted by law you may treat this amount as state or local tax paid in the year the credit is applied. All right so for more information on that one you could take a look at the safe harbor rules Treasury reg one point one six four dash three J so US territory taxes so include taxes imposed by a US territory with your state and local taxes online five a five b five c however don't include any US territory taxes you paid that are allocable to include to included income. Tip you may want to take a credit for US territory tax instead of a deduction. So again these this is kind of a more specialty area so if you're working in tax preparation you might want to be thinking OK am I just doing taxes for people that work in a particular state. Do I want to do taxes possibly for people that have income that cross state borders which gets complicated in and of itself because different states have different types of taxes. And you're going to possibly need more complex software at least to help you as well as understanding the differences in different states. And then when you get to people that have territories or like foreign income then of course the rules become a little bit more complex there as well. And so so again the question if you're doing tax preparation is what kind of clients do want do you want to specialize on how complex of a returns do you want to be doing and then stick to the plan. And don't let people convince you to do more complex returns because they want an exception for this or that or the other things just do stick to your stick to your plan. This is my plan dang it. This is my this is my business. So see the instructions for Schedule 3 form 1040 line 1 for details. So line 5 a caution. You can elect to deduct state and local general sales taxes instead of state and local income taxes. You can't deduct both. Now how did this come up. Now remember if we're if we're allowed to deduct state taxes on the federal tax return then the question comes up well how does the state tax. It used to be that they would only allow the income tax which of course caused some states to conform to an income tax system that could maximize the capacity for deduction. Like California and New York right so now they're going to say I'm going to try to maximize my capacity to have state and local tax deductions for people which basically means. We're going to we're going to be subsidizing the state taxes and paying it by the federal government right. Whereas other states said hey look I don't want to design my tax system based on what the federal government says because the states are sovereign and possibly they think that a different tax system. But rather than an income tax system would work better such as like a sales tax system. So some states like like Texas I think is going to have like a sales tax system. And so then so then finally later on that they came to the idea of well this is kind of unfair that we're allowing some states to get a deduction for state taxes when all states still have to pay for their own stuff. Some states are just better at it right then others they seem to be more efficient. So we should be able to deduct the sales tax instead of the income tax for those states that have a sales tax that you're paying for. Then the question comes up well how are you going to deduct the sales tax because it's a little bit more difficult to calculate sometimes and then we have tables and methods that you can use to deduct the sales tax. So this will probably be dependent on the state that you're in. So if you do state taxes for a particular state if you're in California you're going to be doing most people are going to be taking this the state tax and not the sales tax because the state tax is going to be the income tax is going to be high typically. But if you're in other states then you might have the sales tax and again if you do state if you do returns for multiple states then that could be a little bit confusing and you want to make sure that you get straight in terms of how you're going to be working that out. So state and local income taxes. So if you don't elect to deduct general sales taxes include online five a the state and local income taxes listed next state and local income taxes withheld from your salary during two thousand twenty three. Now. Most people when they pay their taxes. Similar to the federal income taxes. If you have a state tax system will have withholdings. So places like California and I believe like New York for example mirrored the federal income tax system in part so that they can maximize the tax deductions and subsidize this. So that so that means that the tax system is going to be looking much the same in terms of the withholding system. So the the the employers going to be required to withhold the money from the wages like with the federal income tax system and then you'll see them reflected on the W2. When we think about the deductibility of state taxes we typically are talking about a cashed based system. We're talking about the state taxes that we paid for most people we pay the state taxes through the withholdings and therefore the data input into the software should be fairly straightforward. For most tax returns because the W2 will have the withholdings and that will help us to calculate the deductibility of the state taxes on a cashed based system. But some people might have a a estimated tax payments in which case you got to make sure you put in the estimated tax payments for like a business kind of situation. And again the sales tax messes everything up because then they're not going to have the withholding system set up and you're going to have to use some other system to calculate the sales tax. So your form W2 will show these amounts forms W2 DG 1099 G 1099 R 1099 miscellaneous and 1099 NEC may also show state and local income taxes with help. So these are all those income type forms we talked about in the income section. They may not have withholdings they're less likely to have withholdings than the W2 except possibly the 1099 R for retired individuals. But they could have the same kind of withholding. However, don't include online 5A any withheld taxes you deducted on other forms such as schedule C, E or F. So here we come up with the same kind of problem that we saw with the medical type of expenses, meaning the normal kind of things we can deduct are those things that we use to help generate revenue. If we had to pay certain state taxes as part of our business then you would think it would at least be a more of a legitimate deduction and therefore would be deducted more legitimate in that it aligns with what you would expect from an income tax system. So it wouldn't be a personal deduction it would be a business deduction and therefore deducted on like a schedule C for sole proprietorship. If it was allowed as a deduction on a schedule C you can't also deduct on the schedule A because then you would be doubling up on that. We'll see examples of that when we get to say the real estate taxes for example where you might use like part of your home for a business for example. State and local income taxes paid in 2023 for a prior year such as taxes paid with your 2022 state or local income tax return don't include penalties or interest. Now this is where it gets a little bit messy because we're basically on a cash based system with regards to when we can deduct things. However when we pay the taxes we're going to apply them to a particular year. So for example if you pay estimated tax payments you have to pay quarterly estimated tax payments. The last quarterly payment for let's say 2023 isn't due until 2024. So when do you get the deduction you paid the money for tax year 2023. If it was the state tax do you get the deduction in 2023 or 2024. Well typically you get the deduction in general on a cash basis when you paid the tax not when you applied not dependent upon what year you applied the tax to. That's kind of like the general rule. State and local estimated tax payments made during 2023 included any part of a prior year refund that you chose to have credited to your 2023 state or local income taxes. So in other words let's say you had a refund of state taxes not federal but state taxes in 2022. So instead of them giving you the money you said I just want you to keep the money IRS and count it as an estimated payment for tax year 2023. Well that would be like you getting the money in a check and then paying it back to the government as an estimated payment in 2023. Therefore it should be a cash payment in essence that was made in 2023 and therefore possibly deductible tax year 2023. Now also note that penalties are not normally deductible so don't include it says penalties and interest here. So so meaning like you owed your tax and then they charged you penalties and interest on on top of that the penalties and interest are typically not going to be deductible as a state tax. Right so they don't want to incentivize people for the penalties. That seems straightforward but again can be confusing because then you have to determine how much of the payments for penalties and interest which the IRS tells you in the form. But typically if you just look at the payments that you made to them you might not see the breakout between penalties and interest but any case. So mandatory contributions you made to the to the California New Jersey or New York Non Occupational Disability Benefit Fund. Rhode Island Temporary Disability Benefit Fund or Washington State Supplemental Workmen's Compensation Fund. So those are kind of specialty areas if they apply to you there. Mandatory contributions to the Alaska California New Jersey or Pennsylvania State Unemployment Fund. Mandatory contributions to state family leave programs such as the New Jersey Family Leave Insurance the FLI program and the California Paid Family Leave Program. Don't reduce your deduction by any state or local income tax refund or credit you expect to receive in 2023. In other words you would think that if whatever I paid in 2023 then I shouldn't deduct all of it right because I'm going to get a refund. Right if I paid 10,000 in 2023 and or if I paid like like 3000 in 2023 and I'm going to get 1000 back as a refund wouldn't I only deduct 2000 because I overpaid and they're going to give me the money back. But the idea is well no we're going to be in a cash based system. You overpaid this year when you get the refund next year. That's when we determine if you got a benefit in the current year then you would have to include it in income next year. That's how the general system is going to work. So if you paid 3000 taxes this year to the state and you're going to get a 1000 refund. If you didn't get any deduction for it this year because you didn't itemize because your standard deduction was greater than the itemized deduction. Then you're going to get the 1000 back in 2024 and you they'll tell you about it but you don't have to include it in income because you didn't deduct it in 2023. But if you got a deduction in 2023 you benefit of the deduction for $3000 in 2023 then they give you a 1000 refund back in 2024 because you got a deduction for that 1000 benefit in 2023 you have to then pay or include it in income in 2024. So that's the general the general idea that we saw on the income side of things. So refund of or credit for prior year state and local income taxes you actually received in 2023 instead see instructions for schedule one form 1040 line one. So you might say okay well what if I got a refund of state taxes in 2023 for the overpayment of taxes that I paid in 2022. So if I paid 3000 of taxes this year shouldn't I reduce that amount by the refund that I got from 2022. No that's not generally how it works because you're going to you're going to put the amount that you paid and if you have to include the refund in income. You're not going to make the adjustment on the deduction side on the schedule a you're going to make the determination to fix the prior year because you would have over deducted possibly in the prior year. You're going to fix that not by amending last year you're going to fix that not by reducing the amount of the schedule a deduction this year but rather by determining if you have to include it in income on schedule one which we talked about in the income section. Thank you.