 Income tax 2023-2024, taxable refunds, credits or offset of state and local income taxes, tax software example, get ready and some coffee so we can recognize the quacks while doing income tax preparation 2023-2024. First a word from our sponsor. Yeah, actually we're sponsoring ourselves on this one because apparently the merchandisers they don't want to be seen with us. But that's okay whatever because our merchandise is better than their stupid stuff anyways. Like our trust me, I'm an accountant product line. Yeah, it's paramount that you let people know that you're an accountant because apparently we're among the only ones equipped with the number crunching skills to answer society's current deep complex and nuanced questions. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. Form 1040 tax software example using LASERT tax software. You don't need tax software to follow along but if you have access to tax software, it's a great tool to run scenarios with. You can also get access to the forums, schedules, instructions at the IRS website irs.gov, irs.gov. Starting at our normal starting point with our taxpayer Adam Taxman just trying to avoid a dang taxman living in Beverly Hills 90210 starting off as a single file or no dependence. We have W2 income at the nice round 100,000. The standard deduction 13850 giving us the taxable income 86150. If we look at that in a formula format in Excel, we've got the 100,000 income. We've got the standard deduction 13850 giving us the taxable income 86150. And then the tax calculated by the software 14266 represented in page two of our software. There's the 14266. Let's go back to page one. Now we're looking at income that is flowing through through the schedule one. Now remember that if you were to construct a tax return, for example, you probably constructed something like this making a general outline formula and then having other schedules, worksheets basically feeding into that formula. However, because of the way the tax returns have been structured over the years, they wanted to try to fit everything on one page for a long period of time. And therefore you have all of this stuff basically on the first page of the tax return related to income. But now that the tax returns are electronic, it makes sense that you have more of schedules to increase the complexity rather than trying to fit everything on one page of a tax return. And you can see that's what they did more and more starting a couple of years ago. They added some of these schedules. So now on line eight, I'm going to put a little check next to it. We have the additional income from schedule one line ten. So let's take a look at schedule one then. If I go into schedule one, here we go. And then we have schedule one part one line number ten is going to be adding all of this stuff up, which will then feed into the first page of the form ten forty, which will be our income line item. We're focused on the first one here, which is going to be the taxable refunds credit or offset of state and local taxes. Okay, so the general rule for this one is that you will oftentimes get a 1099, I believe, G from the state. And that will be dependent upon the state that you're in and whether your state has an income tax system. If they have an income tax system that mirrors the federal income tax system, then it's likely that you're going to do the same kind of thing. You try to overshoot the payment of your taxes because you don't want to get hit with penalties and interest to stick from the state. And then in the following year, so if you overpaid your taxes in two thousand twenty two, you're going to get a refund. And when you get a refund, you might get that 1099 G that is telling us that there's a refund and also going from the state to the federal government to tell the federal government that you got a refund. And usually when there's a 1099, it has to be included in income. However, this one is a bit of an exception for many cases. And just to kind of recap why this might be the case, note, if we imagine this is the income taxes for the federal income taxes. Note in page two, we have an amount due at this point in time. If I was to imagine that we overpaid the taxes, let's go back in here and say that we overpaid and we paid like 16,000 of withholdings. Then of course we would have a refund, which we're trying to do to avoid that penalty. And so that's how we do it. We get a small refund. We're shooting for a small refund because I would rather have my money sooner rather than later having bigger paychecks rather than smaller paychecks. Now this of course is a tax return for tax year 2023 that we are filing at some point in 2024. If I tell the government that we have overpaid and we want to get some of that money refunded to us, it's going to be refunded to us in 2024 for payments that were made in 2023. Now if we get a check in 2024, we know the general rule is low money that we've received has to be included in income unless it says otherwise by the code from the IRS. But in this case, it wouldn't really make sense for us to include this in income because this is simply an overpayment. This isn't actually income. We paid them too much in taxes for tax year 2023. So when I received this overpayment in 2024, it wouldn't make sense for me to include it in income. However, when we look at the state taxes, we have a similar situation on the state tax return. So for example, I live in California that has a state income tax system and it kind of mirrors the federal income tax system. If I overpay on the state and I have a refund from the state, then of course I wouldn't include that refund on the state tax return as income. However, I might have to include it on the federal income tax return as income. Why would that be the case? Because sometimes the state taxes are deductible for federal income tax purposes on the Schedule A. So if I go to the Schedule A, you can see in the taxes, we have possibly the capacity to deduct state taxes. Now, the idea then would be, well, what if I pay the state taxes in, let's say 2023 in our case, if we paid the state taxes in 2023 and got a deduction for it, then what would happen if I overpaid the taxes and then they gave me money back in 2024? Then it would be like, well, now I got a deduction in 2023 for money that they just gave back to me. And that would of course incentivize people to do something like overpay their state taxes in 2023 so that they can get the deduction in 2023. And then the money is just going to come back to them in 2024 in the form of a refund. Therefore, there's got to be a fix to that. What's going to be the fix? Well, it could be that you only deduct what's in 2023 that is actually going to be incurred in 2023, but that would be an accrual principle and it's easier to do taxes on a cash-based system. So the general concept is if I paid the taxes in 2023, then I get the deduction in 2023. You could amend the tax return for 2023 once you get the refund, but that would be a big pain. So the easy solution is saying if you got a benefit in 2023, then you're going to have to record it in income of 2024, which kind of makes sense. That would be the easy thing to do. I'm not going to go back and fix last year. I'm going to say I got a deduction last year. Then I got a refund of part of the money that I got a deduction for. Therefore, I'm going to include it in income in the current year. That's the principle. Now, it seems fairly straightforward, but there's a lot of kind of caveats to it if I have to basically include it in income. It's also a bit complex as well because not all states have a state income tax. Some people might have a sales tax, some states and some states might have a sales tax and an income tax. And you might try to pick one for federal income tax purposes and which one to deduct, which we'll talk more about later. So if you have a sales tax, it's less likely that you're going to get a refund from the sales tax, but it's possible that you get some kind of refund of the sales tax that you overpaid, in which case you might be in a similar scenario. So the bottom line is this. If you get a refund, you're going to get a 1099 for it, but the 1099 might not be included in income and it wouldn't be included in income if you didn't get a tax benefit last year and you would get a tax benefit on the Schedule A. So if you're talking about a lower income individual, one typically that doesn't own a home because owning a home is usually what pushes people over to itemizing because of the interest or mortgage, the interest on the mortgage payments and the state taxes with regards to property taxes. Even if they own a home, they might not be itemizing. So the question is if you're taking on a new client, for example, which is usually the most difficult thing, then you would say, okay, last year, did they itemize? If they did itemize, I would suggest that they have a more complex return and you might want to take their prior year return and actually do the data input into the software for the prior year so that you can properly do the rollovers in the software from one year to the other because there might be some rollover impacts that the software can help you drill down on, such as this tax or do you have to include state taxes in income. If they didn't itemize last year, you're probably dealing with a more simple return and possibly you don't need to do that, you could just start doing the data input in 2023 because 2022 probably you can figure out exactly what happened. There's not a complex kind of rollover type of situation. That would be the general concept because note, if they did take the deduction last year, you might say, well, that's easy, I can just include it in income. If they itemized last year, then I will include it in income. However, that might not always be the case. Why wouldn't that be the case? Well, they might not have gotten a full tax benefit. Let's say they had a $5,000 refund from the state that they received in 2023. They itemized last year, which means they had the taxes that they were going to pay as a deduction but they were really close to being able to take the standard deduction. Let's say they were close to the threshold of the $13,850 to take the standard deduction and then they just barely, let's say their itemized deductions were $14,000. Well, then they didn't get the full $6,000 of benefit when they paid it. They only got the difference between what they would have got on the standard deduction and the itemized deduction. So now you don't want to include the full amount in income. You only want to include the amount if possible that you have to, which might be the amount that they actually got a tax benefit for. The other common thing that happens is they might be taking an itemized deduction but they live in California and there might be a cap then on the state taxes, which you can easily go over if you live in California or in New York because there's a high cost of living and the state taxes have frankly been taking advantage of the federal tax system which allows you to deduct state taxes on the federal return, which is basically subsidizing high-tax places basically, right? So they put a cap on that. So what if I have taxes that hit the cap, then I can't further deduct the taxes and I might not be getting a benefit past the cap that I hit on the taxes that were paid. So again, I only want to include the amount in income that I got a tax benefit from last period. So you can see how those kind of things will impact the calculation. You want to know them in theory and then use the software to help you to calculate those issues and then deconstruct the tax return for an explanation to make sure the software is doing it correctly and so that you can explain the rationale to a client or to yourself or to an auditor or whatever. Now one more kind of weird thing that could happen is that they could have state taxes as well as sales tax. You might be in a state that has state tax and sales tax and for whatever reason they might have taken the deduction or elected to deduct their sales tax because it was higher than the income tax for whatever reason and then you got a refund of the income tax. Well, now they itemized and they took the taxes deduction but it wasn't the income tax that you got a benefit from, it was the sales tax. So it's another kind of weird scenario that could come up. Okay, so given that this is the rookie mistake that most people will do. They'll get the 1099 and they'll go, okay, here it is, additional income for taxes. I'm going to jump to that in my data input and I'm going to say, okay, it's a 1099G and then I'm going to say this came from the California, let's just say it did and then we're going to go, okay. And then it's going to be a state and local income tax refund and let's just say it was $5,000. So then we're going to say, all right, then let's go back on over to the forms and you're going to go, what? It didn't show up here. I did the data input and it didn't show up in the return. Why? Because the software doesn't know whether or not the taxpayer got a deduction for it last year because we didn't roll over the tax return. So if you're not using the same tax software to roll it over from last year to this year, the software is going to by default possibly not include it in this line item even if you do the data input because it's going to assume that there was no tax benefit from it last year. So if there was a tax benefit from it last year, you got to say, okay, do I want to enter last year's tax return in the software in 2022 even though it might cost me some money because it's a more complex situation and then the rollover will happen and that might help me to calculate this software or basically I just want to force it to happen in the current year, right? So for example, this software has the capacity to basically do the data input like a worksheet so itemized in 2022 income tax deduction or sales tax deduction and you could basically go through this worksheet and that will help you to calculate the tax to see whether or not the refund should be taxable in the current period or you can force it with an override. Now note that most softwares have this kind of override thing for a lot of things and you don't want to use it most of the time because that means you're overriding something, you're defaulting something so you would probably want to in practice use the worksheet in most cases unless you're sure that it all should be included in income or you should again do the data input better, more better yet do the data input of the prior tax return in the prior software, roll it over and then this calculation will be basically done for you but I'm going to say I'm going to override it with tax return let's say a number one and then we're going to go actually I'm going to put the dollar amount here in the override, 5,000 and then I'm going to go back on over and then basically I forced it to happen now so now it's pulling over and I can see it and I go okay there it is and then I'm going to pull it down and say okay 5,000 5,000 is then going to pull over to the page one of the form 1040 so now I've got the 100,000 and the 5,000 is being pulled in from the additional schedule one form so the bottom line is you can force that to work but don't think that you have to include it just because you got the 1099 it's dependent upon what happened in the prior year let's do a quick adjustment to our worksheet over here because now we have the schedule one so I'm going to make a whole another schedule now so I'm going to right click on this and say let's actually just make a new tab over here let's just make a new tab and then I'm going to put it next to the income because I'm going to call it schedule one schedule one let's say income and so I'll make another tab I'm going to select the whole thing right click format the sales I'm going to make it currency negative numbers bracketed and red no dollar sign, get rid of the pennies and I'll make it large and I'm going to go this is going to be schedule as the schedule one income I should probably name it more formally additional income I'll just say income and then I'm going to say this let's make the whole thing bold and then I'm going to say this category is called see if they won't let me copy that taxable refunds let's just call it taxable refunds taxable refunds and so I might make this headers so I'll make this black and white due to home tab font group we'll make it black and white and I'll make this black and white black or bordered black white and then I'm going to say we have a refund we probably only need a couple lines for that so I'll make this bordered and blue and I'm going to say the refund the amount was 5000 and then I might have another line over here to see how much of it was taxable or not so that I can do the data input and then I can see how much is taxable which I'll be reliant in part on the software to help me calculate so I can see both sides kind of double checking my data input and then I can say the total total total taxable refund will be on the outside equals the sum and in this case all of it has been included I'm going to go back to my first and then this will be the total schedule one income which will be equal to this 5000 I'm going to include that in line one of my formula so here's my formula double clicking on it this is coming from this tab now I'm going to add a whole other tab which is going to have my schedule one income and so there's that 105 and then that comes down to 13850 and then that taxable income is 91150 so I'm going to go ok 91150 let's go back on over here and say do you we're at 91150 page 2 calculating the tax is now at the 15366 so I'm going to say ok 15366 and so there's our calculation now if the tax wasn't included say what if I still got the 1099 but it's not included in income then I can kind of see it in my data input form this way and say ok I input it over here into here but then the software saying it's not included in taxes which I'm going to trust the software to do if I properly rolled over the tax return so I can kind of double check it and say well why is that they didn't itemize last year they got this refund but it's not included and therefore should not be pulling over into my income line item because they didn't get a benefit from it last year so that's the general idea so if it's a basic tax return the basic idea is that you're going to get a 1099 most people panic about it and try if you're kind of a rookie tax preparer to put it in to the schedule and then it doesn't show up because the software didn't get a benefit from it last time and because this is a more complex return if they did get a benefit from it and you have a schedule A I again would recommend actually inputting the software the tax return into the prior software and rolling it over helping you to do the calculation or if you don't want to do that possibly because it'll cost you money to do that then you could use the worksheet to help you do the calculation because if you get a tax benefit from it last year doesn't necessarily mean that all of the income is subject to income taxes because some of the oddities that we mentioned