I’m trying to complete my 2006 tax return and can’t find my copy of what I filed in 2005. One of the questions in Turbo tax is about any refunds you got last year - I guess they tax you on that as income. Seems unfair - but anyway - I need to report it and can’t find the info. I imagine if I spent ALL day in a phone maze with the IRS I could eventually find out, but am trying to avoid this. Any other ideas?
Even if I do get that number, should I then subtract the $725 I later had to pay after they audited me and found that I calculated a child care expense dedecution incorrectly?
You get taxed on STATE and LOCAL tax refunds from the prevoius year, not on FEDERAL tax refunds. And only under certain conditions. For example, you must have itemized deductions last year, in which case you would have deducted those state and local taxes last year, so it’s only fair that if they were refunded, you now have to be taxed on them. If you didn’t itemize deductions last year, the refunds aren’t taxable this year.
TurboTax should explain all of this to you. I believe when I filled out the questionnaire it asked the appropriate questions.
For your 2005 taxes, assuming you itemized deductions, you would have deducted the total amount you paid to the state or local tax agency, as shown on your W-2 form.
There are other possible complications, in rare cases, but that’s the common situation.
On the Federal return, you are allowed to take a deduction for state and local taxes that have been paid.
So, the first year that you work, your W-2 shows up with the information that you had $200 withheld to pay state taxes.
When you pay your federal taxes, you deduct the $200 from your taxable income.
However, when you calculate your state taxes, you wind up getting a $15 refund. So, now, you have reduced your taxable income by $200 when you should have reduced it by only $185. The $15 you got back, (since you used it to reduce the income on which you paid taxes the previous year), becomes income.
Alternatively, having had $200 withheld from your income in the first year, when you calculate your state tax, the bill comes to $220 and you have to write a check to the state for $20.
The next year, your W-2 says that your company has withheld $208 dollars (supposing tax rates have gone down but you got a raise and had more tax withheld), so you get to declare both the $208 that was withheld and the $20 check you mailed to the state as a state tax deduction.
And, as each year will probably have different amounts withheld and deducted, (based on changing tax laws and changing income), the amount that you can deduct or that you must declare as income may swing back and forth.
If you used Turbo Tax for your 2005 taxes, the 2006 Turbo Tax will automatically refer to the taxes you paid in 2005 if you make that available to 2006.
Tom~'s information is generally correct as far as it goes, with a quibble and a significant limitation.
The quibble is that the state or local tax refund is not in fact income, but rather is a reduction/repayment of an item that may (or may not) have been a deduction in a prior year.
This is relevant and significant because the prior year state or local tax refund is only relevant if you itimized deductions in the prior year on your federal return and took the state or local tax as an itemized deduction. If you just took the standard deduction, the amount of state or local taxes you paid was not a deduction from your taxible income, so a refund of state or local taxes shouldn’t be a taxible event. If you did use it as a deduction in the prior year, you must include it as though it were in the current year to balance out the excess deduction from the prior year. (If you’re into the AMT regime, I have no idea how this works out.)
In any event, how state and local taxes were treated on the prior year return is highly relevant to how any refund is to be treated this year.
This is only a general explanation of how this theoretically works. I am not your lawyer or tax advisor. Please consult with a qualified tax professional to see how this works in your specific instance. Good luck.
