Healthcare and Other Fringe Benefits Update

May 9, 2019

Written by TaxSpeaker
Home of Ron Roberson our 2019 2-Day Federal Tax Conference Presenter! See Conference Details

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We just received an email question in our Taxspeaker Q&A series about a mid-size client receiving a $400,000 penalty letter for failing to provide health insurance to employees. There continues to be an incredible amount of incorrect information about health insurance rules for small and medium size businesses, health care related fringe benefits and other employer provided fringe benefits after TCJA. 

The IRS just released new guidance on the taxation of state tax refunds as a result of the TCJA limits on state and local tax deductions. Part of our fall 1040 and our 1040 Boot Camp will include in-depth discussion of the topic, and I decided to include the several hours of work on my part in this week’s newsletter for your use, so read on. This is a tough topic!

The IRS released Revenue Ruling 2019-11 in 2019 to explain how to handle the taxability of individual state income tax rules after 2017’s TCJA limited the state and local income and property tax deduction to a maximum of $10,000 for the years 2018-2025. The limitation does not apply to foreign taxes or to business taxes.

The problem and solution are related to something called the tax benefit rule which, in layman’s terms, states that a refund in a later year of something deducted in an earlier is taxable in the later year, but only if it actually provided a tax savings in the earlier year. This rule, from Internal Revenue Code Section 111, has been applied for decades. As an example, if in prior years a taxpayer did not itemize deductions, later state tax refunds were not taxable because no “tax benefit” had been received from the amounts paid in the earlier year.

With the new rules it is also possible that a state tax refund may not be taxable even if the taxpayer itemized in the prior year!
 
The new rules utilize the same tax treatment but require a lot more calculation. The new rules state that the later year refund is taxable in the later year if the taxpayer received a benefit in an earlier year, limited to the lesser of:

  1. Amount of state and local refunds received in later years, or
  2. Net prior year itemized deduction change (Schedule 2), or
  3. Reduction of itemized deductions to the standard deduction limit.

Schedule 1

 

Col. A
Prior Amount

Col. B Current Refund

Col. C Net Prior Amount

1 Prop. Tax

 

 

 

2 State/Local Tax

 

 

 

3 Total Paid

 

 

 

4 10,000 Limit

 

 

 

5 Actual Tax Benefit, Lesser of Line 3 or 4

 

 

 

A5-C5 Adjustment Amount

 



Net Adjusted Itemized Deductions Schedule 2

 

Unadjusted Prior Year

Less Sch. 1 Adjustment

 Net Prior Year Itemized

Medical

 

 

 

Taxes—Sch. 1

 

 

 

Interest

 

 

 

Charity

 

 

 

Other

 

 

 

Total

 

 

 

 

 
Example 1-Non itemized prior year Marie Curie (single, standard deduction $12,000 in year of example) has itemized deductions of $10,000 in the current year, which includes $8,000 of state income tax. She does not itemize in the current year and receives a $1,000 state tax refund in the next year. Her taxable amount is the lesser of:
 

  1. $1,000 actual refund received, or
  2. $0 net prior year itemized deduction change, or
  3. $0 net itemized deductions less standard deduction.

 

 
Example 2-Limited to benefit amount-No reduction of $10,000 prior year tax deduction Marie Curie (single, standard deduction $12,000 in year of example) has itemized deductions of $20,000 in the current year, which includes $12,000 of state income tax (limited to $10,000 under TCJA). She itemizes in the current year and receives a $1,000 state tax refund in the next year. Her taxable amount is the lesser of:
 

  1. $1,000 actual refund received, or
  2. $0 net prior year itemized deduction change, or
  3. $8,000 net itemized deductions less standard deduction.

Schedule 1

 

Col. A
Prior Amount

Col. B Current Refund

Col. C Net Prior Amount

1 Prop. Tax

 

 

 

2 State/Local Tax

12,000

-1,000

11,000

3 Total Paid

12,000

 

11,000

4 10,000 Limit

10,000

 

10,000

5 Actual Benefit

10,000

 

10,000

A5-C5 Adjustment

0

 
 

 

Unadjusted Prior Year

Less Sch.1 Adjustment

Net Prior Year Itemized

Medical

 

 

 

Taxes--See Sch. 1

10,000

0

10,000

Interest

8,000

 

8,000

Charity

2,000

 

2,000

Other

 

 

 

Total

20,000

 

20,000

 
 

 

 
Example 3-Refund Fully Taxable Marie Curie (single, standard deduction $12,000 in year of example) has itemized deductions of $20,000 in the current year, which includes $4,000 of state income tax and $5,000 of property tax for total taxes of $9,000. She itemizes in the current year and receives a $1,000 state tax refund in the next year. Her taxable amount is the lesser of:
 

  1. $1,000 actual refund received, or
  2. $1,000 net prior year itemized deduction change, or
  3. $7,000 net itemized deductions less standard deduction. (19,000-12,000)

Schedule 1

 

Col. A
Prior Amount

Col. B Current Refund

Col. C Net Prior Amount

1 Prop. Tax

5,000

 

5,000

2 State/Local Tax

4,000

-1.000

3,000

3 Total Paid

9,000

 

8,000

4 10,000 Limit

10,000

 

10,000

5 Actual Benefit

9,000

 

8,000

A5-C5 Adjustment Amount

 
-1,000



Net Adjusted Itemized Deductions Schedule 2

 

Unadjusted Prior Year

Less Sch. 1 Adjustment

Net Prior Year Itemized

Medical

 

 

 

Taxes—Sch. 1

9,000

-1,000

8,000

Interest

8,000

 

8,000

Charity

3,000

 

3,000

Other

 

 

 

Total

20,000

 

19,000

 
 
 

 

 
Example 4-Refund Partly Taxable-SALT limits Marie Curie (single, standard deduction $12,000 in year of example) has itemized deductions of $21,000 in the current year, which includes $5,500 of state income tax and $5,000 of property tax for total taxes of $10,500. She itemizes in the current year and receives a $1,000 state tax refund in the next year. Her taxable amount is the lesser of:
 

  1. $1,000 actual refund received, or
  2. $ 500 net prior year itemized deduction change, or
  3. $8,500 net itemized deduction-standard deduction. (20,500-12,000)

Schedule 1

 

Col. A
Prior Amount

Col. B Current Refund

Col. C Net Prior Amount

1 Prop. Tax

5,000

 

5,000

2 State/Local Tax

5,500

-1.000

4,500

3 Total Paid

10,500

 

9,500

4 10,000 Limit

10,000

 

10,000

5 Actual Benefit

10,000

 

9,500

A5-C5 Adjustment Amount

 
-500


Net Adjusted Itemized Deductions Schedule 2

 

Unadjusted Prior Year

Less Sch. 1 Adjustment

Net Prior Year Itemized

Medical

 

 

 

Taxes—Sch. 1

10,000

-500

9,500

Interest

8,000

 

8,000

Charity

3,000

 

3,000

Other

 

 

 

Total

21,000

 

20,500

 

 
Example 5-Refund Partly Taxable-Standard Deduction Limit Marie Curie (single, standard deduction $12,000 in year of example) has itemized deductions of $12,700 in the current year, which includes $5,500 of state income tax and $4,000 of property tax for total taxes of $9,500. She itemizes in the current year and receives a $1,000 state tax refund in the next year. Her taxable amount is the lesser of:
 

  1. $1,000 actual refund received, or
  2. $11,700 net prior year itemized deductions, or
  3. $700 net itemized deduction-standard deduction. (12,700-12,000)

Schedule 1

 

Col. A
Prior Amount

Col. B Current Refund

Col. C Net Prior Amount

1 Prop. Tax

4,000

 

4,000

2 State/Local Tax

5,500

-1.000

4,500

3 Total Paid

9,500

 

8,500

4 10,000 Limit

10,000

 

10,000

5 Actual Benefit

9,500

 

8,500

A5-C5 Adjustment Amount

 
-1,000


Net Adjusted Itemized Deductions Schedule 2

 

Unadjusted Prior Year

Less Sch. 1 Adjustment

Net Prior Year Itemized

Medical

 

 

 

Taxes—Sch. 1

9,500

-1,000

8,500

Interest

0

 

0

Charity

3,200

 

3,200

Other

 

 

 

Total

12,700

 

11,700

 
 

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