The IRS Response On Special Tax Refunds

A little over a week ago, the Internal Revenue Service asked all recipients of Special Tax Refunds including additional state income and property tax refunds to hold off on filing their returns. Near the close of business last Friday, we received their response.

These additional tax payments should not be included as additional income on your federal return. That’s great but this begs a further question.

Since these payments were considered additional state income tax refunds or additional property tax rebates, are the payments includable as additional deductions? Just because we don’t have to pick them up as additional income doesn’t mean that we can take an additional deduction.

This question wasn’t answered. My advice is don’t do it.

Please understand that the most basic concept in taxation is that we’re never supposed to pay a tax on a tax. This is why we get deductions at the Federal Level for state income and property tax payments.

In order to understand the problem, let’s use an example.

Last year you filed your state income tax return and paid $2,000. Sometime last year, the state sent you an additional income tax refund of $100. The question becomes can you deduct $2,000 or $2,100 on your federal return?

Please realize that the IRS has a copy of your state return and knows exactly what you originally paid in tax. If you take the additional deduction, they’ll probably question it and send you a correction letter.

Their correction will charge you additional tax, interest, and penalty. By the time they’re done, it’ll probably cost you a lot more than the original hundred.

The same thing is true on the additional property tax rebate. They know what your property taxes actually cost. If you take the additional rebate as a deduction, they’ll probably question it and ask you to pay the tax difference plus interest and penalty.

Let me leave you with this.

Whether you’re selling household items on Ebay or walking dogs on the side and receiving compensation through Venmo, your side hustle creates a taxable event. Many think that if a payment processor isn’t filing annual paperwork with the government, they don’t have to include the income on their returns.

Nothing could be further from the truth. It’s income. And if you don’t have a formal entity set up, it belongs on a sole proprietor’s return.

The problem is that as Schedule C / Sole Proprietor income, you’re set up to pay the maximum amount of tax legally allowable by law for an active trade or business in the US. You must pay Federal and State income as well as payroll taxes including Social Security and Medicare.

It’s common to pay upwards of 35% on Sole Proprietor income. If you earned as little as $10K on your side hustle, that would be an increase of $3,500 in tax.

If you’re in a higher tax bracket, it’ll be more.

If you find yourself in this predicament, there are reasonable solutions to the problem. Please give us a call. We’d love to help.

Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Employee Retention Credits, M&A Due DIligence, Payroll Services, or Accounting and Tax Work, you have but to ask. I’m here and I remain,

Sincerely yours,

Chris Amundson
Accounting Solutions Ltd.

Note that the only professional services provided by Accounting Solutions Ltd. are those specified in a written communication from our office detailing the scope of services to be rendered and the terms and conditions applicable to the engagement.