IRS Revenue Ruling Clarifies Treatment of SALT Refunds in Age of $10K Limit

By:
Chris Gaetano
Published Date:
Apr 1, 2019
abundance-banknotes-bills-545064 (1)
A recent IRS revenue ruling explains how taxpayers should treat state and local tax (SALT) refunds arising from any year in which the new $10,000 limit on the deduction is in effect. Under the Tax Cuts and Jobs Act, the previously unlimited federal SALT deduction was capped at $10,000 as a way to meet budgetary constraints during the drafting process. This cap, however, raised the following question: If a taxpayer received a tax benefit from deducting state and local taxes under section 164 of the Internal Revenue Code in a prior taxable year, and the taxpayer recovers all or a portion of those taxes in the current taxable year, what portion of the recovery must the taxpayer include in gross income? 

The revenue ruling lays out four hypothetical scenarios in answer to this question. But, the IRS noted, "Today’s announcement does not affect state tax refunds received in 2018 for tax returns currently being filed."

* Situation 1: Taxpayer A paid local real property taxes of $4,000 and state income taxes of $5,000 in 2018. A’s state and local tax deduction was not limited by section 164(b)(6) because it was below $10,000. Including other allowable itemized deductions, A claimed a total of $14,000 in itemized deductions on A’s 2018 federal income tax return. In 2019, A received a $1,500 state income tax refund due to A’s overpayment of state income taxes in 2018.

In this case, the state income tax refund is fully includable. 

* Situation 2: Taxpayer B paid local real property taxes of $5,000 and state income taxes of $7,000 in 2018. Section 164(b)(6) limited B’s state and local tax deduction on B’s 2018 federal income tax return to $10,000, so B could not deduct $2,000 of the $12,000 state and local taxes paid. Including other allowable itemized deductions, B claimed a total of $15,000 in itemized deductions on B’s 2018 federal income tax return. In 2019, B received a $750 state income tax refund due to B’s overpayment of state income taxes in 2018

In this case, the state income tax refund is not includable. 

* Situation 3: Taxpayer C paid local real property taxes of $5,000 and state income taxes of $6,000 in 2018. Section 164(b)(6) limited C’s state and local tax deduction on C’s 2018 federal income tax return to $10,000, so C could not deduct $1,000 of the $11,000 state and local taxes paid. Including other allowable itemized deductions, C claimed a total of $15,000 in itemized deductions on C’s 2018 federal income tax return. In 2019, C received a $1,500 state income tax refund due to C’s overpayment of state income taxes in 2018.

In this case, the refund is partially includable: 

"In 2019, C received a $1,500 refund of state income taxes paid in 2018. Had C paid only the proper amount of state income tax in 2018, C’s state and local tax deduction would have been reduced from $10,000 to $9,500 and as a result, C’s itemized deductions would have been reduced from $15,000 to $14,500, a difference of $500. C received a tax benefit from $500 of the overpayment of state income tax in 2018. Thus, C is required to include $500 of C’s state income tax refund in C’s gross income in 2019," said the ruling. 

* Situation 4: Taxpayer D paid local real property taxes of $4,250 and state income taxes of $6,000 in 2018. Section 164(b)(6) limited D’s state and local tax deduction on D’s 2018 federal income tax return to $10,000, so D could not deduct $250 of the $10,250 state and local taxes paid. Including other allowable itemized deductions, D claimed a total of $12,500 in itemized deductions on D’s 2018 federal income tax return. In 2019, D received a $1,000 state income tax refund due to D’s overpayment of state income taxes in 2018.

In this case, the taxpayer should just use the standard deduction. 

"In 2019, D received a $1,000 refund of state income taxes paid in 2018. Had D paid only the proper amount of state income tax in 2018, D’s state and local tax deduction would have been reduced from $10,000 to $9,250, and, as a result, D’s itemized deductions would have been reduced from $12,500 to $11,750, which is less than the standard deduction of $12,000 that D would have taken in 2018. The difference between D’s claimed itemized deductions ($12,500) and the standard deduction D could have taken ($12,000) is $500. D received a tax benefit from $500 of the overpayment of state income tax in 2018. Thus, D is required to include $500 of D’s state income tax refund in D’s gross income in 2019," said the ruling. 

The IRS said that the ruling has no impact on state or local tax refunds received in 2018 and reportable on 2018 returns taxpayers are filing this season. 

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