State Property Tax Credits – Tax Problem Resolution

Memo explains how state property tax credits are taxed and reported – Chief Counsel Advice 200814022

Mike Habib, EA

myIRSTaxRelief.com

In Chief Counsel Advice, IRS has explained the proper federal income tax treatment of certain state property tax credits and the extent to which the state must provide information reports about the credits to IRS under Code Sec. 6041 or Code Sec. 6050E.

Background on tax benefit rule. In general, a taxpayer who receives a refund of state taxes previously deducted on a prior year’s federal income tax return must include the refund in gross income in the year received to the extent of any federal income tax benefit, unless all or part of the income is excluded under Code Sec. 111. A taxpayer who receives a refund of state taxes that were not previously deducted on a prior year’s federal income tax return is not required to include the refund in gross income in the year received. (Rev Rul 93-75, 1993-2 CB 63)

Facts. State X real property taxes are imposed on a calendar year period and become due Date 1 of the following year. Taxpayers receive a discount if they pay their real property taxes by Date 3.

State X mobile home taxes are imposed on a calendar year period and become due Date 2 of the same year. Taxpayers receive a discount if they pay their mobile home taxes by Date 3.

State Statute A provides for a homestead income tax credit for individuals during Year 1 and Year 2. The credit is equal to 10% of the real property taxes or mobile home taxes that were levied against an individual’s homestead, became due during the tax year, and were paid anytime before filing the income tax return claiming the credit (including a timely filed amended return). If the credit exceeds an individual’s state income tax liability, the taxpayer can carry forward the unused credit for up to five years. Alternatively, he can request that the state tax commissioner issue a certificate for the unused portion of the credit. The certificate can be used against any of the taxpayer’s real property tax or mobile home tax liabilities that become due during the tax year following the year for which the taxpayer claimed the credit. The counties in State X will treat the receipt of a certificate as a payment when it is transferred to them. The counties will have the authority to implement a system that applies the certificate to the following year’s liability or (at the county’s option) also permits a cash refund if a taxpayer has already paid the real property tax or mobile home tax liability that becomes due during the income tax taxable year following the year for which the taxpayer claimed the credit. This election to carry forward or receive a certificate is irrevocable.

State Statute B provides for a commercial property income tax credit for individuals and corporations during tax years Year 1 and Year 2. The amount of the credit is equal to 10% of the real property taxes or mobile home taxes that were levied against a taxpayer’s commercial property, became due during the tax year, and were paid anytime before filing the income tax return claiming the credit (including a timely filed amended return). If the credit exceeds a taxpayer’s income tax liability, the taxpayer can carry forward the unused credit for up to five years but there is no option to receive a certificate for the unused portion of the State Statute B credit.

Federal taxable income is used as a starting point in calculating State X income tax for corporations as well as individuals, and there is no add back if a taxpayer claims the Statute A or B credit and takes a deduction on the federal return for real property taxes or mobile home taxes paid or accrued. Consequently, the State Statute B credit is in addition to a deduction for state income tax purposes.

Proper tax treatment of State Statute A credit. The CCA concluded that the following general tax treatment applies when the State Statute A credit exceeds an individual’s state income tax liability:

    • the credit carryforward should be treated as a reduction in the taxpayer’s state income tax liability in the carryforward years and
    • the use of a certificate to timely satisfy a real property tax or mobile home tax liability should be treated as a reduction in the taxpayer’s real property tax or mobile home tax liability.

    Each of these reductions affects the amount deductible under Code Sec. 164(a). Additionally, in a county that permits a refund if a taxpayer has already paid the real property tax or mobile home tax liability that becomes due during the tax year following the year for which the taxpayer claimed the credit, such a refund would be subject to the general rules concerning the tax benefit rule, as discussed above, for taxpayers using the cash method who receive the refund in a year after the real property tax or mobile home tax liability was paid. If the real property tax or mobile home tax refund occurs during the same tax year those taxes were paid, the refund reduces the amount otherwise deductible under Code Sec. 164 by a taxpayer using the cash method.

    Proper tax treatment of State Statute B credit. The CCA observed that the State Statute B credit can affect only a taxpayer’s state income tax liability for the year the credit is claimed or for a carryforward year. Accordingly, this credit should be treated as a reduction in a taxpayer’s state income tax liability. This affects the amount deductible under Code Sec. 164(a)(3).

    Information reporting. Code Sec. 6050E requires information reporting for state and local income tax refunds. Form 1099-G is used for this purpose. The CCA said that, in the case of State Statute A, if a taxpayer uses the credit against his state income tax liability for the year the credit is claimed, and receives a refund of state income tax for that year, the amount of the refund must be reported by the state refund officer on Form 1099-G. A copy of the Form 1099-G must be sent to the taxpayer. (Code Sec. 6050E(b)) However, the refund officer need not furnish this statement to the taxpayer if the refund officer verifies that the taxpayer did not claim itemized deductions for federal income tax purposes. (Reg. § 1.6050E-1(k))

    If the credit is carried forward and applied to reduce state income tax liability in subsequent years, any state income tax refunds in those subsequent years will be subject to Code Sec. 6050E reporting.

    The use of a certificate to pay, reduce or obtain a refund of real property or mobile home tax is outside of Code Sec. 6050E, as it is not a state income tax refund. Instead, any information reporting for a certificate would be based on Code Sec. 6041, which requires information reporting for payments of $600 or more made in the course of a trade or business for rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable gains, profits, and income. If the refund is reportable under Code Sec. 6041, the amount reported would be shown on a Form 1099-MISC, in box 3 “Other income.”

    Reg. § 1.6041-1(b)(1) and Reg. § 1.6041-1(i) provide that payments made by a state or a political subdivision are subject to this reporting requirement. Payments are only reportable under Code Sec. 6041 to the extent they constitute fixed or determinable income. Under Reg. § 1.6041-1(c), income is fixed when it is to be paid in amounts definitely predetermined. Income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained. A taxpayer’s use of a certificate to timely satisfy real property or mobile home tax is treated as a reduction in the tax liability and not as income. Therefore, there is no required reporting under Code Sec. 6041 as there is no fixed or determinable income. If, however, the county permits a refund based on the application of the certificate, there may be income if the taxpayer previously deducted these taxes, based on the tax benefit rule. In that case, the refund must be reported on Form 1099-MISC to the extent it is income. The county does not have a reporting obligation if it cannot determine the amount that is fixed or determinable income.

    In the case of State Statute B, a taxpayer can only use the credit to reduce its state income tax liability for the year the credit is claimed or a carryforward year. Any state income tax refund received by individual taxpayers must be reported on Form 1099-G, under Code Sec. 6050E, regardless of whether all or part of the refund does not constitute income. Code Sec. 6050E does not apply to state income tax refunds issued to corporations.

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