 Income tax 2022-2023, taxable refunds, credits, or offset of state and local income taxes. Let's do some wealth preservation with some tax preparation. Most of this information comes from the Form 1040 Instructions Tax Year 2022 Instructions for Schedule 1, Additional Income and Adjustments to Income. You can find on the IRS website, irs.gov, irs.gov. Looking at the Income Tax Formula, we're still focused online on that being income. Remembering that the first half of the Income Tax Formula is, in essence, an income statement. Although a strange one, income up top, the equivalent of expenses being the deductions is down to the equivalent of net income, that being taxable income. Our goal being the opposite of a normal goal for an income statement to have the taxable income, the bottom line as low as possible, to reduce the number of taxes. When we look at the income then, the top line, the question is, is this income and if it's income, is it something that we have to include as taxable income or is it exempt for some reason? In that case, or in this case, we're applying that concept to the taxable refunds. So if we look at the Form 1040, we're down here in Other Income from Schedule 1. This is the common layout that we would kind of expect if you were to create, like the Form 1040s from scratch, you might not put all of this stuff in the income line on page one of the 1040, but rather have summary lines that are going to be leading to other schedules that have all of the stuff on it. Why? Because that's going to simplify the forms and people that have more simple... 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. Simplified tax returns will simply have less schedules to attach. Why didn't they do that before? Because before we had software, the idea was that they want to put everything on one basically 1040s so everyone can just have one sheet and that was thought to be the easiest way, which it probably was at the time. But these days you're filing electronically so it doesn't make a lot of sense or it's not a lot easier to just have one form that basically has one sheet that will conform to everybody but you have this concept of other schedules that will feed into it and so we'll see some play and see where the tax code goes going forward to see how they kind of format the form 1040 going forward given that structure. But here we have the schedule one and we're looking at the tax refunds, credit, or offset of state and local income taxes. Now normally this is going to be seen in the format of possibly you get a 1099 type of form that's going to say that you've got a refund from say a state tax that was overpaid in the prior year. So we're looking at 2022 so if in 2021 you had an overpayment of a state tax then you might get a type of 1099 which is usually a 1099G or something like that. It's usually an indication the 1099 form that is that you have to include something in income but if you think about it you might say well that seems a little bit funny because it's going to be a return of an overpayment. Why would I have to record that in income? So let's just go through the general scenario to understand. I understand. I understand. That you basically got to understand that the state and local taxes are different from the federal income taxes. The federal tax system is mainly funded meaning we pay for stuff on the federal level, the primary goal being military protecting us, keeping us safe. We pay for that with an income tax primarily. And then the states are typically going to be responsible for what they need to handle on the state level and the state should be able to determine whatever tax system that they want to use. They don't necessarily need to mirror the federal government in terms of an income tax but might in play apply instead something like a sales tax or something like that or possibly they will mirror an income tax type of system. So most commonly the general scenario is that you have an income tax type of system on the state level which is mirroring what is happening on the federal level. Something like happens similar in California which has an income tax type of system. Now for some reason they said that the taxes on the state level is something that's deductible possibly on the Schedule A when you have the itemized deductions for the federal income taxes which is a little bit odd and again this is one of those things that if you were to start the tax code from scratch you probably wouldn't want to do that because that puts a lot of influence in terms of how the states are going to be taxed. Tax purposes. Because they're going to get a benefit in taxing in certain ways if you give them a deduction on the federal side for taxing and so on and so forth. The problem is once the tax system is in place it's hard to pull the deductions out because people have planned on them and so on at this point in time. So there's been debate about that system in and of itself. Should we be able to deduct state taxes on the federal side of things? How much should we be able to deduct? Should there be a cap on it? And they kind of limited the amount of deduction that you can take in a few years ago and they also increased the level of the standard deduction which means less people will be itemizing. So the general rule would be well if you've got a tax benefit from the prior year tax return on the state side and you got to deduct the state taxes that you paid and you deducted the amount that you actually paid in state taxes then you got a benefit of a deduction. And if they then give you a refund because you overpaid the state taxes that means you got an over deduction. You got to deduct more in 2021 than you otherwise would have been able to deduct because they gave you the money back. How are we going to deal with that? Well, you could go back and amend the federal income tax return to amend the itemized deductions so that it reflects the amount that's not going to be refunded back or we could just say if you get a refund and you got a benefit from it you have to include it in income in 2022. So that's the general scenario. So how does that play out then in practice? The general rule is going to be if you get a form that's saying that you got a refund from the state a 1099G or something like that then if the person did not itemize last year and typically people aren't going to itemize unless they have a home because the mortgage interest and real estate as we'll talk about later are the things that push people over to itemizing if they did not itemize last year then they likely didn't get any tax benefit from the state taxes and therefore you don't have to include it in income. However, if they did itemize last year that's when you may have to include it in income if they got a benefit from the state taxes which gets complicated because then you've got to think about did they really get a benefit if they itemized because there's a difference between the standardized deduction and the itemized deductions and there's also a cap in terms of how much state taxes are deductible so then you have to get into the weeds and say well did they actually get a benefit even though they can itemize from the state taxes state tax, federal tax, social security tax and how much then do I have to include in the current year the best tools for that are typically software to help with those calculations and if you have a situation where you have more complex returns a return for example has itemized deductions then oftentimes it's beneficial if it's a new client not just to start inputting from 2022 but rather recreate the tax return from 2021 in your software and then roll it over from the software so that these kind of things those rollover items will the software to help to populate it okay given now given that line one, taxable refunds credits or offsets of state and local income taxes if you received a refund credit or offset of state or local income taxes in 2022 you may be required to report this amount if you don't receive a form 1099G check with the government agency that made the payment to you so typically you'll get a 1099G the 1099 is the form that usually indicates that you have to record something as income but like we said it's only income in a certain situation if you got a benefit from it in the prior year okay so your 2022 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 a form 1099G so like all 1099s if you have income and you didn't get the document you still should record it and it could be that you just didn't get the document because it's electronically generated it will be if it has been generated the IRS will have it so if you put something different on your form then what the IRS has it's going to cause you problems so if you choose to apply part or all of the refund to your 2022 estimated state or local income tax the amount applied is treated as received in 2022 so in other words you might say well I didn't get a refund because I would have got a refund let's say I filed my 2021 tax return I had a state tax refund but I didn't take it because I applied it over to the estimated tax payments for the following year meaning we usually pay our taxes from the withholdings of the W-2 or possibly if you have a schedule see business you make estimated payments and I just took that refund and said keep it and that will be part of my payments that I'm going to be making for the year 2022 well in that case that's basically the same as you got the refund from your 2021 taxes and then wrote them a check and put it back in as an estimated payment for 2022 so it's still we're in the same spot of you might have gotten income you have to include it if you got a tax benefit from the deduction on the federal side for 2021 which means you would have itemized the deductions and so on so if the refund was for a tax you paid in 2021 and you deducted state and local income taxes on your 2021 schedule A use the state and local income tax refund worksheet these instructions to see if any of your refund is taxable now that gets complicated the worksheet again it seems fairly straightforward you can say well obviously if it's an if they did not itemized which many people don't they don't have a schedule A but rather they just took the standard deduction then it's straightforward they didn't get a benefit from it last year easy so if you get a new client and they didn't itemize last year you probably may not need to actually enter their data into the 2021 tax return to have the software roll it over because it's a pretty easy return but if they did itemize and you got this refund type of thing the question as to did they actually get a benefit from the state taxes is not as straightforward as you would think you would think well yeah they got a benefit because they itemized but there's still like a difference between the standard deduction and the itemized deduction that gap to put people over to itemizing can cause you kind of issues in terms of actually determining what the benefit was and there's a cap on the amount of state taxes which further complicates whether they got a benefit so you need kind of somewhat of a complicated worksheet that's why software helps and the software will help most most thoroughly if you actually enter the data back into the 2021 tax return mirroring the 2021 tax return for a new client in your software and then roll over the tax return 2022 so the software can help you calculate that kind of worksheet okay explanation see itemized deduction recoveries in publication 525 you can find the iris website instead of using the state and local income tax refund worksheet and these instructions if any of the following applies number one you received a refund in 2022 that is for a tax year other than 2021 so that kind of messes stuff up as well because now normally you would think if you got a refund in 2022 it's because you filed in 2021 but you could have weird situations where someone filed late returns for 2020 or something like that and then you got a refund for a tax year other than the prior tax year which still puts you in a similar situation in terms of did they get a benefit when they filed the 2020 tax return or whatever but obviously that muddies up the whole thing 2. You received a refund other than an income tax refund such as a general sales tax or real estate tax refund in 2022 of an amount deducted or credit claimed in an earlier year so note that it used to be that only the income tax was the main kind of deductible item which was kind of unfair because the states that have the income tax are going to be like California and New York and stuff but a lot of other states would say hey look we don't want to use an income tax we want to use a sales tax or some other tax system and you guys the federal tax system is subsidizing those people using an income tax as opposed to the other tax and whatnot so then they said that if you have a sales tax then possibly you can choose to deduct either the income tax or sales tax so now you have a system well they could have got a benefit from something like the sales tax or something and if they got a refund of the sales tax that they deducted in the prior year less likely for that to happen in that situation but if it does you can see the same kind of issue comes up you got a benefit from it last year you deducted it now you got a refund so either you need to amend last year which we don't really want to do or you have to include it in income this year so 3 you have taxable income on your 2021 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 net capital gain and qualify dividends in certain situations for your 2021 state and local income tax refund is more than your 2021 state and local income tax deduction minus the amount you could have deducted as your 2021 state and local general sales taxes 5 you made your last payment of 2021 estimated state or local income tax in 2022 6 you owned alternative minimum tax you owed alternative minimum tax in 2022 alternative minimum tax kind of goes everything off as well and usually is applied to higher income individual 7 you couldn't use the full amount of the credits you were entitled to in 2021 because the total credits were more than the amount showing on your 2021 form 1040 or 1040 SR Line 16 8 you could be claimed as a dependent by someone else in 2021 9 you received a refund because of a jointly filed state or local income tax return but you aren't filing a joint 2022 form 1040 or 1040 SR with the same person again a lot of these issues might be helped to be able to address by by basically putting the information into the tax software for the prior year rolling it forward hopefully helping or getting help from the tax software so that you can apply these rules and then deconstruct them and say and kind of work backwards or in alignment with the tax software to see what has happened we'll take a look at some examples in the following presentation