As the initial 2015 tax filing season comes to a close in about four weeks, I wanted to address a few miscellaneous tax questions that are often asked of me and my staff during the course of meeting with clients and preparing income tax returns.
A common question I often hear is how my client’s Arizona state tax refund (received in 2015 related to the 2014 income tax return) is taxable on the client’s 2015 federal income tax return. I have many clients who cry foul at this and claim that they are being double-taxed on these funds. This is not the case. A prior year state refund received can be reportable taxable income on the following year’s federal income tax return if the taxpayer itemized their deductions rather than claiming the standard deduction on the previous year federal return and if the taxpayer received an actual tax benefit on the prior year return from claiming their state income tax payments as a deduction on schedule A, itemized deductions. State income tax payments made during a given tax year, whether they are paid through wage withholding or estimated tax payments, can be claimed as a federal tax deduction as part of the tally of itemized deductions for that year. If the taxpayer is able to claim these state tax payments as a deduction such that their federal income tax liability is reduced for that year, any overpayment of state payments received back as a refund the next year will be taxable income on the federal return the next year. This is because the IRS has never taxed this income and does so when the state refund is received the following year. If this were not the case, taxpayers could purposefully overpay their state tax every year and reduce their federal tax liability without repercussion.
Another question I often receive relates to the four Arizona tax credits that are available and whether contributions to charitable organizations that qualify for these credits also qualify for a federal charitable tax deduction in addition to the dollar-for-dollar Arizona tax credit. The answer is yes – any contribution to these qualified charities count as a federal tax deduction if the taxpayer is able to itemize their deductions overall and do not claim the standard deduction instead. Some of these Arizona tax credits can be funded the following year up until the April filing deadline and still count as a credit for the previous year (similar to the IRA contribution deadline). However, the timing of the federal deduction depends on which calendar year the contribution is made in as extra time is not granted related to the federal deduction. Therefore, if a payment that qualifies for the Arizona credit in the previous year is made between January 1st and the April deadline, the federal deduction can’t be claimed until the current year and not on the same return where the Arizona credit is claimed. For reference, the four Arizona tax credits that I speak of are the public schools tax credit (eca), the private school tuition organization tax credit, the qualifying charitable organization tax credit (formerly the working poor credit) and the qualifying foster care charitable organization credit.
One request I often receive from my clients is to delay the filing of their tax returns until closer to the April deadline so that they can accumulate the funds needed to pay their tax liability first. The fact is that it doesn’t matter when the tax returns are actually filed before the April deadline because the deadline to pay the taxes due is still the April filing deadline. Therefore, we can submit the returns electronically as soon as they are complete and the taxpayer can wait until the April deadline to make the payments due. Alternatively, I have clients inquire if they can somehow extend the time to pay the tax they owe for the previous year beyond the April filing deadline. The answer to this question is no since late payment penalties and interest will begin accruing on the day after the April filing deadline if the balance is not paid in full. These penalties and interest will accrue regardless of whether a formal installment agreement payment plan has been arranged with the government or not. The bottom line is that all tax returns due should be filed or successfully extended by their due date and any remaining prior year tax liability should be paid by the initial filing deadline, if possible, to avoid late filing and late payment penalties and interest.
Contact us if you have any questions as we approach the final weeks of the tax filing season.