Question: A friend and I have been arguing about the correct itemized deduction for state income tax. I have always claimed the amount of tax I come up with on my state return. Right?
Answer: Wrong. The correct Schedule A deduction is the amount of state income tax actually paid during the tax year for which you are filing the federal return.
Let's use calendar year 1979 -- the tax return you are working on now -- as an example. The amount of tax you come up with on your 1979 state tax return really has nothing to do with the deduction on your federal tax return.
Instead, the correct federal deduction is the total of all the state income tax you paid during 1979.
The state tax withheld from your pay, as shown on your 1979 Form W-2.
Any additional tax paid in 1979 when you filed your 1978 state tax return.
Any state estimated tax paid in 1979 regardless of the year to which it applied.
Conversely, if you made a payment in January 1980 you claim it on your 1980 federal return, not 1979 -- even though it applied against 1979 state tax.
Any additional state tax paid in 1979 as the result of an adjustment to an earlier year's tax (but not any penalty assessed).
If you get a refund in 1979 on your 1978 (or earlier) state tax, do not subtract it from total payments. Show the total of all 1979 payments on Schedule A; then enter the amount of the refund on line 11 of Form 1040 -- but only if you had itemized deductions on your federal return for the year to which the refund applies.
Caution: If you change to the correct method now, don't take credit a second time for any 1979 payments you had already claimed on last year's federal return.
Q: In 1976 we bought a new home for $55,000, which qualified for the $2,000 tax credit. Early last year we sold that house for $78,000, then bought another home for $90,000. Do we have to repay any of that $2,000 now?
A: No. Let me explain the rules for the benefit of others in a similar situation.
If you claimed the 5 percent tax credit for purchase of a new home, the credit is normally recaptured -- that is, it must be repaid -- if you sell the home within 36 months after acquiring it.
But if you purchase a replacement residence, costing at least as much as the adjusted selling price of the home on which the credit had been claimed, within 18 months after the sale, no repayment is required.
If the replacement home costs less than the sales price of the original home, you will have to repay a part of the original credit.
There are some exceptions. Recapture is not required if the original home was disposed of due to the death of any owner; because of complete destruction by fire, earthquake, or similar casualty; or if the property was condemned.
In the case of a married couple, repayment is not required if the couple has been divorced or legally separated and one spouse retains the home as his or her principal residence.
Use Form 5405 to report any required recapture of the tax credit. IRS Publication 523 has more details.
Q: My W-2 shows $210 as "life insurance premium." Do I have to report this as income?
A: Yes. Apparently your employer has covered you with group life insurance amounting to more than $50,000.
Normally the cost of group life insurance paid for by your employer is a fringe benefit that is not subject to tax. But this tax break applies only up to the $50,000 ceiling mentioned above.
You employer is required to report as "other compensation" on your Form W-2 the premium cost of insurance in excess of that ceiling. Of course, it's still a good deal; all you end up paying is the income tax -- which has got to be less than the premium cost itself.