I made unnecessary state extension payments in 2023 for 2022, resulting in refunds. Shouldn't those refunds be netted against the extension payments?

[gardineiro]

I made extension payments in 2023 for 2022 state taxes. The payments ended up being unnecessary, resulting in refunds for which 1099Gs were issued. I have entered in the 1099G amounts, as well as the extension payment amounts. On the state and local income tax refund worksheet, part I, column g, turbotax is allocating only a very small portion of the refund against the column d amounts. This is automatically calculated by TT and not something it allows me to override--and it doesn't show how the number is calculated. Shouldn't I be able to net the entire amount of my refunds against the extension payments? (It matters because both last year and this year my deductions exceeded the $10K SALT limitation, and not netting out the refund against the extension payments results in reporting additional income for the refunds received during 2023, while generating additional deductions that I cannot use in 2023.

[Mike9241]

I assume you took itemized deductions in 2022 and used state income taxes rather than state sales taxes.  if that's the case netting the payment in 2023 with the refund received in 2023 is not how it works. 

if you want to check the computation done by Turbotax see PUB 525. There is a worksheet in your tax file that computes the taxable portion. if you are using online, you won't be able to see it until you pay any fees that are owed.

https://www.irs.gov/pub/irs-pdf/p525.pdf 

start with worksheet 2a on page 27

be sure to read the instructions 

as an overview a portion of your refund is allocated to the state income taxes you deducted in 2022 with the rest to taxes paid in 2023. the refund allocated to 2022 is the taxable portion. As you will see if you look at the worksheets and instructions other factors enter into determining the taxable portion. 

[gardineiro]

Mike9241, thank you for the info.  Correct, I itemized in both years and used state income tax in both years.

I am using desktop version of TT on windows.  I can see the "state and local income tax refund worksheet" (I'll call this the "TT refund worksheet") as well as the "state and local tax deduction worksheet" and the "tax payments worksheet".  These correctly reflect that I paid $1000 of 2022 extension payments and received $1061 of refunds reflected on forms 1099G.  The TT refund worksheet also correctly reflects that I had a total of $663 of SALT payments in 2022 that were in excess of the $10K SALT limitation.  (And for 2023 I am again in excess of the $10K SALT limitation.)

Pub 525 worksheet 2a explains the calculation that is reflected in part III of the TT refund worksheet.  I don't have any concerns with the actual calculation.  My question is about the inputs to that pub 525 worksheet 2a.  Pub 525 says (at p.25) the following: "Recovery and expense in same year. If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and isn't reported as income." 

This rule, as stated in pub 525, makes practical sense: the fact that I voluntarily made a large overpayment, and received a refund, instead of making no payment and receiving a smaller refund, shouldn't matter.  The two should net out against each other before making the worksheet 2a calculation.  It appears to me that the TT refund worksheet, Part I, column g is intended to implement this rule by offsetting the refund received in 2023 against the extension payments made in 2023.  

However, for some reason, which TT does not appear to explain, column g is only offseting $50 of my $1061 refund, resulting in a refund of $1011 which then becomes the input to the pub 525 worksheet 2a calculation.  My question is why is TT only offsetting this seemingly arbitary $50 amount, instead of fully offsetting the entire $1000 of extension payments against the $1061 of refunds received?

[gardineiro]

So I guess my question boils down to this:

On the state and local income tax refund worksheet, part I, column g, how do I override TT's failure to fully allocate the refund amount against the extension payments?

[gardineiro]

I figured out where column g is pulling its number from.  TT is allocating the refund pro rata against the extension payments and withholding amounts, resulting in only a small portion of the refund being allocated against the extension payment (since my amount withheld is far larger than my extension payments).  This appears to match another portion of pub 525 which provides as follows:

"Recovery for 2 or more years. If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata basis, the recovered amount between the years in which you paid it. This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of your allowable deduction for this item for the current year."

Based on this, my belief has shifted from believing TT is mistaken, to believing the IRS is mistaken. 

In any event, it appears the pub 525 guidance is, if you make a large extension payment, resulting in a large refund--even to the extent that the extension payment ended up being totally unnecessary--prepare to nevertheless report some of that refund as additional income (which would not have existed but for the extension payments), since the refund will be treated as not being entirely attributable to the extension payment, but proportionally applied against prior year's withholding as well.

If TT is going to force us to follow the pub 525 rule, I guess I cannot characterize that as unreasonable. Still, it would be nice if TT would include an explanation or supporting calculation for the column g amount so I don't have to post in this forum and do a bunch of research just to figure out where that seemingly arbitrary number is coming from.

Also, a related piece of feedback re the step by step interview on this point--when TT asks you to input the total of all your state payments and withholding, it would be nice to have better guidance there to clarify what that means, and/or a suggested/prefilled calculation if TT has access to the prior year returns. 

Thanks for the help!