Study: Tax Changes Could Raise Billions

Q:

Mr. Kerstetter:

A tax preparer at H&R Block mentioned to me that the Schedule A deduction for state and local taxes for employees should only be for net taxes, taxes that are paid on the state tax return.  Thus for 2004 taxes, one should prepare their state income tax return first then place the tax paid on the 2004 state tax return onto the Schedule A for the 1040.

I have not heard that this is the “correct” way to report state taxes.

What I am familiar with is to deduct on Schedule A taxes withheld, then count as next year’s income when the W-2G comes.  Or, if taxpayer does not itemize, no income in reportable from the W-2G.

What is the correct method, if there is one?

A:

You are right.  State taxes are deductible on a purely cash basis.  Whatever was paid in during the year can be claimed on that year’s Federal Sch. A.  If the person does receive some of that previously deducted money back, it is considered income on the 1040 for the year in which the refund was actually received or applied to a future state tax year. 

Just because a person itemized on the previous year’s 1040 doesn’t automatically make subsequent refunds taxable.  Under the Tax Benefit Rule, if the state tax deduction didn’t actually result in any actual additional Federal tax savings, refunds of those taxes are not required to be reported as taxable income.  I see this situation a lot when the taxable income figure was negative on the return where the state tax payments were claimed. 

As much as I often poke fun at H&R Blockheads, I can only assume that the preparer with whom you were speaking was sleeping through the section of their training course that covers Schedule A, because that has been the proper procedure for at least the past 30 years I have been in this business.

There are times when the net state taxes are used in some situations.  I prepare a lot of multi-state income tax returns, where we often need to claim a credit against the clients home state taxes for the taxes paid to the other nonresident states.  In those cases, we can only use the actual tax as shown on the other state form.

I hope I’ve cleared this up for you.  I also hope you aren’t seriously considering allowing that Block employee actually prepare your income tax returns.  If this person is so wrong about a very basic simple tax matter, there’s no telling how many other areas s/he is ignorant about.

Good luck.

Kerry Kerstetter

Lawsuit alleges ‘online currency’ scam  – Here’s how a classic privately run Ponzi Scheme is run.  As always, I have a hard time coming up with sympathy for people stupid enough to believe that there is such a thing as a safe and legitimate investment producing guaranteed monthly returns of 30% to 40%.

Lawmakers Look to Tax Cosmetic Surgery – Rulers in some states are equating this idea as just another sin tax, no different from taxes on alcohol, tobacco, and gambling.

Can an S-Corp Help Avoid Certain Taxes? – While I agree that LLCs are often better than S corps for owning investment properties, I can’t stress enough how important  it is to get competent professional advice about the type of entity before setting one up.  Every day, I receive emails and see messages on the online discussion boards from people who set up a corp or LLC without the foggiest idea of what they were getting into. Doing things that way is no different than jumping off a bridge before checking the depth of the water ahead of time.    

Don’t Add More Pain to Taxes With a Bad Preparer – Good tips on warning signs to watch out for.

I have been receiving questions like this one from Ohio CPA Dana Stahl from other tax pros every year since the 1980s:

I’ve seen lots of advertising by TurboTax on TV lately. I wonder if this may cut into our tax prep business to some degree, as has been predicted many times by various commentators (who say user-friendly tax software will take away much of our market!). One story concerning me: I heard from a tax client who said she wasn’t coming back this year. She said she took my data from her 2003 1040 & inputted it into TurboTax, which resulted in an additional $7 refund. Therefore, I must have screwed up when I should have gotten her another $7. I told her to send me a copy of that 1040, and that this was probably due to rounding or something. Oh, well, another one bites the dust.

My reply:

Assuming that your client’s TurboTax actually came up with the exact same figure for taxable income as your program did, a slight difference in the tax is quite possible based on the method the programs use to calculate it. If they do an exact dollar percentage calculation, there will be one figure. If they use the IRS tables, which use $50 wide brackets, there will most likely be a slight difference.

I have seen the tons of TurboTax commercials on TV. My opinion on TurboTax and other consumer tax prep programs as a threat to our profession hasn’t changed one bit since they were first made available back in the 1980s. If there was ever a perfect illustration of the old GIGO (garbage in, garbage out) maxim, tax prep software is it. This covers all tax software, including the heavy duty and very expensive programs that we professionals use.

I have never discouraged my clients from using TurboTax. In fact, I used to have several clients submit their annual tax info to me on a TurboTax print-out instead of my normal organizer forms. I would then enter that data into my tax program and the bottom line numbers never came out the same because I was able to use my knowledge to better enter the info to reduce the clients’ taxes. I don’t have as many doing this any more, as we have mandated most of them to use QuickBooks and to just send me a copy of their QB data file.

As I’ve said since the 1980s, form filler tax services, which just enter numbers onto tax forms (manually or via computer) with no thought as to the various options that may be available, do have a lot to fear about losing business to software like TurboTax. This could very well be the case for the super simple 1040A and EZ clients, which are the bread and butter of the assembly line tax prep outfits. However, we all know that with each additional tax schedule and type of transaction to report, there are dozens of options for how they can be reported in order to minimize the tax hit. This takes much more brain power than the form fillers have and makes those of us who keep up on the tax rules worth the big bucks we charge. I know it sounds crass, but clients who are too dense to understand this aren’t who want to be working with.

Just as with the emphasis on doing your own work and not sending it to India, you may want to highlight something like the fact that you and your staff are entering more than numbers into your computers. You are entering your years of experience and vast knowledge, things that are not included in cheap do it yourself programs.

Anyway; those are my thoughts on that.

Kerry

Indiana GOP Governor Proposes Tax Hike – How does this quote differ from what we have long heard from DemonRats?

“I ask the most fortunate among us, those citizens earning over $100,000 per year, for one year, to pay an additional 1 percent on the income they receive.”

This is too much like Dick Gephardt’s classic description of people who do well as “winners of life’s lottery.”

Bush 2006 Budget Will Not Address AMT or ‘Other Tax Policy Issues‘ – it seems that there’s a limited amount of political capital available for Bush, so he has to prioritize and Social Security reform appears to be winning the contest for his attention at this time.

Bipartisan Group Pushes Permanency for State Sales Tax Deduction – Otherwise, we will only have it for 2004 and 2005 1040s.

Homeowners can expect bigger property tax bite