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SALT deduction tax tip

Key tips and advice the working tax pro can use.
#1
lucyko  
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SCENARIO :

** Client will be itemizing deductions on Sch. A for 2018 because deductions exceed standard deduction
** Will be receiving a state income tax refund for 2018
** Client is subject to SALT limitation of $10,000
** Clients state and local sales tax plus state and local real estate taxes exceed $10,000

In this situation, the client should elect the sales tax deduction instead of the state income tax deduction thereby avoiding reporting the state refund as income on 2019 federal return . You need to check the box adjacent to line 5 b on Schedule A to elect the sales tax .

I utilize Drake software and they automatically chose the sales tax deduction if the sales tax plus real property taxes exceed $10,000.I am nit sure if other tax software makes this determination.

I have several clients who fit this scenario.
 

#2
Webster  
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At this point I am unaware of any guidance on how to allocate RE tax vs. State income tax under the cap. You could consider deducting all the RE tax and as much ST as is needed to reach the cap, for a similar result.
 

#3
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I don't think that it will make much of a difference for my clientele but I will test this scenario in UltraTax and report back. Top notch work, lucyko, for noticing that and pointing it out to us, and I will also applaud Drake for making that a standard bit of programming.

Webster, the principles of §111 haven't changed and there is no guidance needed on SALT refunds. There is no allocation; it's just a pool of expenses that lead to a deduction. Imagine you had $5k in real estate taxes and $8k in state income taxes, and the total deduction was limited to $10k. A refund of $1k in state income taxes means the total of $13k in taxes paid would have been $12k -- still limited to $10k -- and as the tax benefit of the $1k excess was zero, the taxable amount is zero.
 

#4
makbo  
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missingdonut wrote:Webster, the principles of §111 haven't changed and there is no guidance needed on SALT refunds [??]. There is no allocation; it's just a pool of expenses that lead to a deduction.

Yes, it is needed. First, for NII allocation of state income tax deduction, and second, for those states that still allow a full property tax deduction without limit.

(I don't know what you mean by "guidance on SALT refunds", I thought we were talking about guidance on the composition of SALT deduction after the limitation - how much is income tax, how much is property and other taxes).
 

#5
makbo  
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missingdonut wrote: Top notch work, lucyko, for noticing that and pointing it out to us

It's nothing new. It's always been a diagnostic in good professional programs to consider deducting sales tax instead of income tax when the taxpayer is subject to AMT. Since the TCJA is essentially bringing the same type of limits to regular tax as are in the AMT (limited SALT deduction, no personal exemptions, no equity mortgage interest, etc), it's just the same old advice as we have always followed.
 

#6
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makbo wrote:Yes, it is needed. First, for NII allocation of state income tax deduction, and second, for those states that still allow a full property tax deduction without limit.

(I don't know what you mean by "guidance on SALT refunds", I thought we were talking about guidance on the composition of SALT deduction after the limitation - how much is income tax, how much is property and other taxes).


Refunds of SALT are the only reason that the composition of the limited SALT deduction is relevant (for regular income tax purposes). You are correct that IRS guidance could be needed for a NIIT allocation, but that was not part of what lucyko or Webster had mentioned. For the states that allow a full property tax deduction, well, the IRS isn't and shouldn't be in the business of providing guidance on whatever tax law non-conforming states choose to have. For those states, the prior interpretations of §111 should be sufficient unless they decide otherwise.

makbo wrote:It's nothing new. It's always been a diagnostic in good professional programs to consider deducting sales tax instead of income tax when the taxpayer is subject to AMT. Since the TCJA is essentially bringing the same type of limits to regular tax as are in the AMT (limited SALT deduction, no personal exemptions, no equity mortgage interest, etc), it's just the same old advice as we have always followed.


I tried a test return with lucyko's situation. To put numbers to it, I used $9k real estate taxes, $2k in sales tax, and $6k in state income taxes. UltraTax used state income tax instead of sales tax, and the diagnostics only told me that income taxes were chosen and that the deduction is limited to $10k. Since UltraTax didn't even give me a diagnostic to suggest choosing sales tax instead of the default (let alone optimize it for me), is it not being a good professional program for 2018?
 

#7
makbo  
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This is a little more subtle, since in terms of next year's taxable refund (recovery), it doesn't matter what you actually picked. You can always include the sales tax amount to determine your taxable refund, even if you deducted the income tax.

Pub 525 wrote:"If you could choose to deduct for a tax year either:

State and local income taxes, or

State and local general sales taxes, then

the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you didn't choose to deduct for that year."

So in your example, even if you deduct some portion of the $6K state income tax (how much?), for TY2019 state tax refund, you could treat the $10K as being composed of $9K real estate and $1K sales tax.

How would you "optimize" in your example? Why would $1K of sales tax be better/worse than $1K of income tax, given that it would have the same result for TY2019 refund taxability.

As for diagnostics, well yes, maybe at this point Drake has a diagnostic and UT doesn't. Maybe UT never will (although I will withhold judgement until the production release is available). However UT has always had the AMT diagnostic, and I've always ignored it, for the reasons explained in this post: it doesn't matter.
 

#8
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You're right; I didn't think about that aspect of §111, so it wouldn't matter which one is used. Clearly I need more sleep.

Thanks, makbo!
 

#9
makbo  
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In fairness, I too didn't think about it until I had a night's sleep. :oops:

The key take-away (since this is a "tips" forum), is that you should always calculate the current year sales tax deduction, even if you don't use it, so that it is available to pro forma to the following year, in case there is a state tax refund in that following year.
 

#10
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odd how different tax software previously handled reporting of state income tax refunds. ProFx would tell you how much of current year refund was taxable next year, but ignore the AMT no tax benefit effect.

UT gave a worksheet.

Go System did nothing current year and nothing following year. You had to compute it yourself. The tax software macho equivalent of smoking Lucky Strikes.
 


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