The Internal Revenue Service (IRS) recently published a new revenue ruling that provides guidance on the proper treatment of refunded state and local tax (SALT) payments that had been deducted on a prior-year individual federal income tax return. Revenue Ruling 2019-11 (Rev. Rul. 19-11) is consistent with, and illustrates the effects of, the federal SALT payment deduction limits enacted by the Tax Cuts and Jobs Act (TCJA). The ruling generally requires refunds of SALT overpayments that were deducted on a prior federal tax return and provided a tax benefit, to be included as federal taxable income in the year refunded.
New Dollar Limitation on Federal Tax Return Deductions of State and Local Taxes
For tax years beginning January 1, 2018, through January 1, 2025, the TCJA limits federal tax return itemized SALT payment deductions for state and local income, sales, and property taxes.1 The TCJA’s SALT deduction limit is a combined total deduction of $10,000 for joint returns of married individuals, and $5,000 for returns of married individuals filing separately, and all individuals not filing a joint return. Prior to the TCJA, there was no dollar limitation on the deduction amount of SALT paid or accrued during a tax year.
The Tax Benefit Rule and Refunds of Previously Deducted SALT Payments
Rev. Rul. 19-11’s central theme is to show how part of the Tax Benefit Rule applies in the context of the TCJA’s SALT deduction limitations. In general, the Tax Benefit Rule requires taxpayers to include as income on their federal tax returns the refunded SALT payments that were deducted in a prior tax year and thus reduced the taxpayer’s tax liability. This aspect of the Tax Benefit Rule applies especially when an improper deduction for prepaid or overpaid SALT resulted in any reduction in federal tax liability, providing a tax benefit. On the other hand, the same rule excludes from gross income, refunds of any amount deducted in any prior year that did not reduce the amount of federal income tax imposed in the year deducted.
Revenue Ruling 2019-11
Rev. Rul. 19-11 announced the following rule, which illustrates the interplay of the Tax Benefit Rule and the TCJA’s SALT deduction limitations: If, in a prior tax year, a taxpayer received a tax benefit from a federal SALT deduction, and in the current tax year receives a refund of all or a portion of the SALT payments that gave rise to the deduction, then the taxpayer must include in current-year federal tax return income the lesser of the difference between either of the following:
- The prior tax year total itemized deductions taken, and the itemized deduction amount that would have been taken if the proper amount of state and local tax had been paid; or
- The prior tax year total itemized deductions taken, and the standard deduction amount that could have been claimed had the taxpayer not been precluded from taking the standard deduction.
As examples, the IRS presented four situations to show how the rule announced in Rev. Rul. 19-11 works. In addition to comparing total itemized deductions, all the examples indicate that the itemized SALT deductions (i.e., as a component of total itemized deductions) must also be analyzed to see if SALT deductions were limited by the TCJA’s SALT deduction limitation.
Two of the examples demonstrate key take-aways. Situation Two shows that if SALT deductions are denied because of the TCJA’s SALT limitation, and if a SALT refund is received that is less than the denied SALT deduction, then there will be no refund amount reportable as income on the federal tax return. Additionally, Situation Four makes clear that if the amount that should have been deducted—in the event of no SALT overpayment—is less than the standard deduction amount, then instead, the standard deduction must be used in the calculation of the amount of the refund that must be included in current year federal income.
The IRS has noted that Rev. Rul. 19-11 has no impact on SALT refunds received in 2018 and is not reportable on 2018 federal tax returns.
If you would like to speak with a tax professional for more in-depth information about this Revenue Ruling or other individual income tax rules or related tax planning, contact a PYA executive below at (800) 270-9629
1 The TCJA’s SALT federal tax return deduction limitation is subject to certain exceptions and special rules for certain types of taxes which are not the subject of this article.
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