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02 / 04 / 2015 by Greg Freyman, CPA in State Tax

How State Taxes Impact Federal Tax Returns

Let us review the concept of how state taxes impact federal tax returns.

On New York State tax forms IT-201-I, or IT-150, or NYC-202(4), the taxpayer is subject to either individual or business income tax. However, on Schedule A or Schedule C of federal form 1040, the taxpayer may deduct state and local income taxes. Specifically, if the taxpayer elects to itemize deductions on Schedule A, state and local taxes would be included in the schedule. Please note though that the state taxes remitted during the year are generally not equal to the total amount due at the end of the tax year. Moreover, the taxpayer will end up either owing additional taxes or receiving a refund for taxes overpaid.

Let take a closer look with the following scenario: if a taxpayer paid (or withheld) a total amount of $5,000 in state and local income taxes throughout the year, but the amount of total state and local income taxes due is $4,000, the taxpayer will be eligible to receive a refund of $1,000 from the state. Furthermore, if the taxpayer itemizes deductions on federal form 1040, they may deduct income taxes paid of $5,000.

In the following year, the taxpayer will need to increase their federal income by a $1,000 to account for the state tax refund from the prior year. Hence, the taxpayer would need to recapture and report this amount on line 10 of form 1040. Furthermore, since state and local taxes are not deducted or itemized, nor are they considered taxable income, the taxpayer will need to reduce their income on the state tax return to arrive at the correct taxable income.

Let’s review another concept in how state and local taxes impact a federal return. The metropolitan commuter transportation mobility tax (MCTMT) tax is imposed on certain New York City employers and self-employed individuals engaging in business within the metropolitan commuter transportation district. The tax is .34% through 2011 and .34%, .23% or .11% for 2012. However, self-employed individuals may deduct the tax on line 23 of Schedule C. Please note that this deduction is not applied to the taxpayer’s state tax return, and it will be added back to the amount deducted previously to arrive to the correct taxable income for the tax year.

In effect, the concepts cited above are similar; however, they work in the opposite direction, as one is a subtraction from New York State taxable income and the other is an addition to New York State taxable income. If you have more New York state tax questions, let us know.

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