Page 586 - TaxAdviser_2022

STATE & LOCAL TAXES

Illustration of tax-benefit rule

Federal taxable income Credit state Exclusion state
(partner/shareholder level)

$ 465,750 $ 465,750
Ordinary K-1 income
($500,000 less SITP $34,250) ($500,000 less SITP $34,250)
Standard deduction (12,950) (12,950)
Federal taxable income $ 452,800 $ 452,800

State taxable income Credit state Exclusion state
(partner/shareholder level)

Federal AGI $ 465,750 $ 465,750
SITP/exclusion 34,250 (465,750)
Standard deduction (8,000) (8,000)

State taxable income 492,000 0
State tax due 30,000 0
Credit or estimated (34,250) (12,000)
tax payments credit estimated tax payment
State tax refund $ 4,250 $ 12,000

taxpayer’s federal return. Conversely, the However, a taxpayer’s receipt of a state taxable income to the extent of the fed-
$4,250 state income tax refund created income tax refund and a benefit from a eral deduction received. Because the
by the credit state was entirely related to credit associated with an SITP does not federal deduction related to an SITP may
the credit associated with the SITP. As a automatically cause the state income tax not always match the associated credit, it
result, it must be included in federal tax- refund to be includible in federal taxable is important for advisers to disclose the
able income in the following year, since a income. Careful review of the state order- amount of the federal deduction received
federal benefit was derived in deducting ing rules for credits and payments will to properly calculate state income tax
the entire credit amount of $34,250 be necessary. refund federal inclusions.
when calculating federal taxable income. For example, if a state requires a The impact of state ordering rules is
Many tax advisers have become resident credit to be applied first, credits highlighted in the table “Examples of
accustomed to not reviewing the tax- associated with SITPs second, and with- State Ordering Rules” and assumes a
benefit rule in relation to state income holding taxes and estimated tax payments standard deduction was taken when com-
taxes since the passage of the TCJA, last, the state income tax refund would puting federal taxable income.
as more individual taxpayers are either generally have to exceed the estimated In Example A, the state ordering rules
taking the standard deduction or have or withholding tax payments before it is require the credit be applied last, which
enough state and local taxes, other than necessary to determine whether the state results in the PTE owner’s including the
state income taxes, to maximize the income tax refund would be includible in state income tax refund in federal taxable
$10,000 federal deduction when item- federal gross income. income in the following year. However, in
izing. The need to review state income However, some states require that Example B the estimated and withhold-
tax refunds and determine whether credits associated with SITPs be applied ing tax payments were applied last, and a
they were generated by a credit associ- last when ordering credits and payments. federal standard deduction was taken. As
ated with SITPs will cause additional If a state income tax refund is received a result, none of the state income tax re-
administrative burdens and disclosures when the credit is applied last, it would fund is required to be included in federal
going forward. be required to be included in federal taxable income.

44 November 2022 The Tax Adviser