This deduction is simple if your only federal tax payments were from paycheck withholdings. You simply report whatever is shown on your W-2 for federal tax withholding. If you’re married and file a separate Iowa return (which most married couples do), each spouse simply reports whatever his or her W-2 shows for federal tax withholding.

It can get a lot more complicated if you’re married, made estimated tax payments, and file your Iowa return as married filing separately (which most dual-income couples do).

This is what I’m going to focus on in this post.

Not So Simple

The deduction for federal estimated tax payments is NOT always claimed 100% by the spouse who made the payment. Additionally, joint estimated payments are NOT always split 50/50.

Instead, the deduction is allocated based on the ratio of income not subject to income tax withholding.

Example Setup:

Angie and Alex are a married couple filling separately on a combined Iowa return. Angie’s income consists of $50,000 of W-2 wages. Alex is self-employed and has net income of $40,000. They have a joint savings account that generated $100 of interest income during the year. Alex made $16,000 of estimated tax payments, in his name only and paid 100% out of his sole proprietorship’s separate business account.

Common sense would say Alex would deduct the full $16,000 of estimated tax payments on his Iowa return. But common sense would be wrong!

Example Answer:

The $16,000 estimated tax payment is NOT deducted 100% by Alex. Instead, you must allocate based on income not subject to withholding. In the case of Angie and Alex, they have $40,100 not subject to withholding — Alex’s self-employment income of $40,000, and the $100 of interest income. The interest income is from a joint account and so is split 50/50, so Angie and Alex each claim $50 of it. 

Even though Alex made 100% of the estimated tax payment out of his own separate funds and in his name only, his allocation of the $16,000 payment is $15,980. Angie is allocated $20 of the estimated tax payment.

Here’s the calculation: Alex’s share of income not subject to withholding = $40,000 self-employment income plus $50 interest income. $40,050 / $40,100 = 99.88% x $16,000 = 15,980. Angie’s share of income not subject to withholding = her $50 share of the interest income. $50 / $40,100 = 0.12% x $16,000 = $20.

Obviously the allocation difference of $20 in this example is rather trivial. But let’s look at an example where the difference would be more substantial:

Another Example:

Let’s say Angie is retired and draws income from IRAs, as well as interest and dividends. Taxes are withheld from the IRA withdrawals but not from the $15,000 of interest or dividends. Assume that these investments are titled in her name only. In addition to the IRA withholding, she also makes $5,000 of estimated tax payments during the year. Alex has not yet retired and still makes $40,000 from his sole proprietorship and pays in $16,000 of estimated tax payments.

The total amount of income not subject to withholding is $55,000 — Angie’s $15,000 of dividends and interest and Alex’s $40,000 of self-employment income. Angie’s percentage of the $55,000 is 27.27% and Alex’s share is 72.73%. In total, they made $21,000 of estimated tax payments — $5,000 by Angie and $16,000 by Alex. 

Angie deducts $5,727 of the estimated tax payments ($21,000 x 27.27%), while Alex deducts $15,273 ($21,000 x 27.27%).

How to Allocate the Deduction for Federal Estimated Tax Payments on Your Iowa Tax Return is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

This part will detail how to handle the state returns. Refer to Part 1 for a basic overview of community property law and to Part 2 for an in-depth analysis of applying community property laws to the actual federal returns that Angie and Alice (the fictional couple being used in this example) filed.

(For people who read Part 2 when it was first published on 5/15 — Part 2 had a few errors and things that needed clarification. You might want to go back and re-read to see the changes. Thanks to an attentive reader named Ray who pointed out the error of my ways regarding dividends, which caused me to make a few other tweaks to parts of the scenario.)

The Mock Federal Return

Same-sex couples must prepare a “mock” federal tax return for use in filing their state returns. The mock return will generally use a filing status of married filing jointly, but a couple couple also use married filing separately. I tell people to use whichever filing status they would have used if they were filing the return with the IRS.

If we refer back to Part 2, if Angie and Alice filed as married filing separately, their taxable income would be exactly the same as in table 1. And their income is such that their tax liability under an MFS filing status is the same as under the single filing status of that table. End result: Angie $8,424 tax liability + Alice $10,774 tax liability + Alice $4,000 early withdrawal penalty = $23,198 total tax liability.

How about married filing jointly? In that case, there’s no community property law to worry about and everything is simply combined onto one tax return. Total taxable income = $108,500. Total tax, including the $4,000 early withdrawal penalty, would be $23,185.

Advantage, by a hair, is married filing jointly on the mock return.

State Returns

Remember, our scenario has Angie and Alice moving from California to Iowa during the year. The first thing they would need to do on the state returns is file their California return. I have prepared California non-resident returns before but am by no means an expert on California taxes. Therefore I’ve decided to leave out a detailed discussion of the California return.

My interest is more in the Iowa return.

In Iowa, most couples with dual income will benefit by filing as married filing separately. I talked about this filing status in more detail here.

Part-year residents of Iowa must first calculate their Iowa taxes as if they were a full-year resident. This means reporting all income from all sources on the Iowa return and calculating their Iowa tax on all income from all sources. Then, they get to take a credit based on the percentage of income earned in the other state vs. earned in Iowa.

So, if a couple files as married filing separately on the Iowa return, does community property law apply in reporting their all-source income on the Iowa return?

The answer is, no. The California income is reported in Iowa 100% by the spouse who earned it. This is true even if Angie and Alice created a mock return with a filing status of married filing separately and applied community property law to their California income on that mock return. Iowa is not a community property state and community property law would never apply to any item on the Iowa tax return. (I should mention that, just to be safe, I did confirm this with the Iowa Department of Revenue before I wrote this blog post!)

Thus concludes this series on multi-state taxation issues of same-sex couples who move from a community property state to a common-law state.

I learned a few things along the way (see the text and the comments section of Part 2 for the things I learned/had to clarify). This is a complex topic but hopefully I helped shed a little light on it.

Same-Sex Marriage, Community Property, And Multi-State Income — Part 3 is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

I have encountered this issue several times in my practice. What follows is a composite of some of these encounters. Please note that “Angie and Alice,” the “client” used in the example below, are fictional characters, not real clients of mine.

The Setup

Angie and Alice are in a same-sex marriage in California. They moved to Iowa in September. Both states recognize their marriage (although I believe that most of this scenario would be the same even if they moved to a state that didn’t recognize their marriage).

I warn you, this is going to get deep. Consider yourself warned!

Here we go:

Wages

Alice earned $56,000 of W-2 income while a resident of California. She had $11,000 of federal taxes and $4,000 of California taxes withheld from this income.

Angie earned $32,000 of W-2 income in Iowa. She had $4,000 of federal taxes and $2,000 of Iowa taxes withheld from this income.

OUTCOME: The California income and withholding must be split 50/50 between Angie and Alice.

Because Iowa is not a community property state, Angie will report 100% of her Iowa wages and associated withholding on her return.

End result: Angie reports $60,000 of income ($28,000 + $32,000) and Alice reports $28,000 of income.

Dividends

Angie earned dividends during the year, on a separate brokerage account in her name only. The statement from the investment company showed $400 of dividends earned while she resided in California, and $200of dividends earned while she resided in Iowa. (For the sake of simplicity, we’ll assume that all dividends are ordinary dividends taxed as ordinary income.)

OUTCOME: In California, dividends, interest and rents from separately held property is NOT community property and is reported 100% by the spouse earning the income. The original version of this story, as published on 5/15, had this wrong. Thanks to reader Ray for catching my mistake (see the Comment section below). So Angie reports all $600 of the dividends on her tax return, including the dividends earned while she resided in California.

Pension Withdrawal

After she moved to Iowa, Alice withdrew $40,000 from a retirement account. $8,000 of federal taxes and $2,000 of Iowa taxes were withheld.

OUTCOME: This is not community property because the withdrawal happened in Iowa. Alice has $40,000 of taxable income to report. She’ll get credit for the full $8,000 of federal taxes withheld and can take an itemized deduction for the $2,000 of Iowa taxes withheld.

Unemployment

Angie was unemployed while living in California. She received $16,000 if unemployment benefits, which ceased upon moving to Iowa. Federal taxes of $1,600 were withheld from these benefits.

OUTCOME: This is community property. Angie and Alice will each report $8,000 of unemployment income and $800 of associated federal withholding on their federal tax returns.

Mortgage

Angie and Alice paid $14,000 on a mortgage for their home when they lived in California. They sold the home at the same time they moved to Iowa. (They sold it at a loss, so no capital gain to worry about.) They paid $4,000 of property taxes on this house. Angie and Alice owned the home jointly.

They also paid $2,000 of interest on their new home in Iowa. Angie and Alice agree that Angie made 100% of this payment. They made no property tax payments in Iowa in 2012.

OUTCOME: The $14,000 of California interest and $4,000 of California property taxes are split 50/50. The $2,000 of Iowa interest is claimed 100% by Angie. So Angie will show a $9,000 mortgage interest deduction, while Alice will show a $7,000 deduction. Note that if the California property was owned entirely by Angie or Alice separately, then only that spouse would claim the deduction.

Charitable Contributions

Angie and Alice made $500 of cash charitable contributions while residing in California. The contributions were made from joint, community funds.

OUTCOME: This is community property. Angie and Alice will each claim a $250 charitable contribution deduction on their federal tax returns.

End Results (using 2012 exemption amounts and tax tables):

 Total refund; $1,402

Here’s how it would look if they didn’t apply community property rules. Angie and Alice would each claim whatever they were entitled to claim, without having to split anything:

Total refund: $1,025

*-Even though we’re not applying community property laws in this table, the California mortgage interest and property taxes should be split 50/50 barring any agreement to the contrary. The charitable contributions were made jointly out of joint funds and thus should be split 50/50 in all circumstances.

You’re a brave soul if you made it this far!

This is just the federal returns. In Part 3, I’ll explore how to handle the “mock” federal return and the state returns.

Same-Sex Marriage, Community Property, And Multi-State Income — Part 2 is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

How does this work when a same-sex couple moves from a community property state to a non-community property state during the middle of the year? It makes for a headache-inducing situation. Indeed, some of the most complicated tax returns I’ve ever prepared have been for same-sex couples that moved from California (a community property state) to Iowa (not a community property state) during the middle of the year.

Background

Most states in the United States follow “common law,” but there are nine states that use “community property” law: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

For tax purposes, community property law treats most income and some (but not all) deductions of married couples as belonging half-and-half to each spouse. When spouses file separate tax returns, each spouse reports half of their own income and half of their spouse’s income.

Note that this only applies when married couples in those states file separate tax returns.

Example:

John and Betty are a married couple in California, which is a community property state. John’s income is $80,000. Betty’s income is $20,000 (so $100,000 of total income as a couple). They decide to file separate federal tax returns. On those separate returns, John and Betty will each report $50,000 of income — 1/2 of their own and 1/2 of their spouse’s income.

How Does This Apply to Couples in a Same-Sex Marriage?

Even though the federal government doesn’t recognize same-sex marriages, the IRS says that couples in same-sex marriages or domestic partnerships (RDPs) in community property states must apply community property laws on their separate federal tax returns. See IRS Letter Ruling 201021048. Couples in same-sex marriages or RDPs in community property states CANNOT file as married, but they MUST apply community property laws.

Example:

Angie and Alice are in a same-sex marriage in California. Because of the Defense of Marriage Act, Angie and Alice cannot file as a married couple on their federal tax returns. They can only file as single or head of household. But they MUST apply community property laws on those federal returns, so they will have to split their income and deductions according to community property laws, same as in the “John and Betty” example above.

Now, let’s muddy the waters and say that Angie and Alice move to a non-community property state, such as Iowa, during the middle of the year. I’ll explore that issue in Part 2.

Same-Sex Marriage, Community Property, And Multi-State Income — Part 1 is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

—–

—–

In the actual e-mail, the words “Get Started” contained a link that almost certainly would download something undesirable to your computer.

Obviously this is a scam/spam e-mail. As I told the client, the IRS never corresponds with taxpayers by e-mail. So if you get an e-mail like this from the “IRS,” the IRS didn’t send it.

Another Example of a Tax Scam E-Mail is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

What’s going on? Some employers are withholding based on the “married” withholding tables rather than the “single” tables.

Example:

Angie is in a same-sex marriage. She earns $60,000/year, payable twice a month (so $2,500/pay period). She claims 0 withholding exemptions. 

Since the federal government doesn’t recognize her marriage, Angie must file her federal taxes as a single person, so her employer should withhold at the single person tax rates. Using the single person rates, her employer should withhold $432.40 from her wages each pay period ($10,378 over the course of a full year).

Instead, Angie’s employer withholds taxes at the married person rates. This results in withholding of $285.90 from her wages each pay period ($6,862 over the course of a full year).

As you can see, the difference between withholding at the single rates or the married rates can result in a huge difference in how much tax is withheld.

In Angie’s case, if all she has is $60,000 of income, the standard deduction ($5,950) and her personal exemption ($3,800), her taxable income will be $50,250, and her tax owed would be $$8,599.

If her employer properly withholds at the single rate, she’ll get a refund of $1,779 ($10,378 – $8,599). If her employer incorrectly withholds at the married rate, she would owe $1,737 ($6,862 – $8,599).

Caveat

One point I want to make is, Angie is not really “paying more” in taxes if her employer withholds at the married rates instead of the single rates. Her tax liability is $8,599. That’s the amount she’ll truly pay in taxes during the year.

The point on the withholding issue is, will she have to pay in when she files her tax return or will she get a refund? But in the end, her tax liability is $8,599 regardless of how much her employer withholds during the year.

Soon a Moot Point?

Of course, this could all become a moot point in late June or early July, if the U.S. Supreme Court overturns DOMA. But for now, it’s something for people in same-sex marriages to watch.

In a Same-Sex Marriage? Watch Your Federal Tax Withholding is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

And if so, how does that work?

Like I said in my post-tax-season recap, returns claiming the EIC make me extremely nervous. I know that all of the EIC returns that I prepared are legitimate. But I still lose sleep — truly — over these returns.

My life would be much easier without EIC clients. But how do you screen them out? Is it ethical to do so?

In MANY cases, I don’t even know a person qualifies for EIC until after they’ve given me their documents and I’ve started working on their return. They have entrusted me with preparing their return. What am I supposed to say? “Sorry, I discovered that you qualify for EIC, so I can’t prepare your return. Come pick up your documents and go somewhere else”?

Most of my EIC clients are hardworking people who have kids and just happen to be in the income range for qualifying for EIC. They are honest people.

Some are sole proprietors whose business income was such that they happen to qualify this year but probably won’t next year. They are honest people.

I have found that many of my EIC clients don’t even know they qualify for EIC, even if they’ve claimed it in the past. And they certainly have no concept of “gaming the system.” They are honest people.

Am I supposed to just say “sorry, find someone else to do this return”?

That’s my conundrum.

I truly freak out about EIC returns. Form 8867 and the things I’m supposed to be asking and documenting seriously scares me.

But the EIC returns I file are legitimate, and the taxpayers are honest people.

So, what are other pros doing in regards to EIC? How are you reducing the stress and risk involved with EIC claims? And if you’re screening people or flat-out refusing service to EIC clients, how do you go about this process?

Actually, I would like to start screening ALL potential new tax clients but I’m not exactly how that would work in the heat of tax season when I’m busy with dozens of other things and people call wanting me to do their taxes. How do I “screen” potential clients? But that’s another blog post for another day.

Are Other Tax Pros Screening EIC Clients? is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

This was my fifth tax season on my own, and it’s the first time where I can honestly say, I didn’t have fun during the season.

It wasn’t all bad, of course. There was good along the way. But taken as a whole, tax season 2013 was mostly unpleasant.

The Good

• I made a bunch of new connections and picked up some great new clients this year.
• 95% of the clients who used my services in 2012 and earlier returned this year.
• My client count grew by a net of 40% over last year.
• My billings for tax preparation work increased by 113% over ALL of my billings last year for all types of work. In other words, if you took my 2012 gross billings for tax preparation, audit defense, bookkeeping, tax advising, business advising, etc., and doubled it (and then some), that would equal what I billed just for tax preparation work alone this tax season. That’s in about a 2-month timeframe. Which leads to….

The Bad

• Crushing workload. I felt unprepared all tax season. The late start to the season and all the form delays played a big role. Add to that the fact that my business grew so quickly, and I was out of sorts all tax season. People who know me know that I am usually over-prepared. I don’t like feeling out of sorts and unprepared. But I fell behind immediately this season, never caught up and never really felt like I was in control of anything. I don’t tolerate that at all, so I’m already plotting ways to make sure next tax season runs better.
• Weird techno-glitches. Whether it was my cell phone (which doubles as my business phone) glitching out for an entire week or my tax software glitching out or my computer system dying in the heat of tax season, or my toddler dunking my business tablet in the cat water, it was a bad season for technology. (The tablet survived, except that the speakers got fried.) Also, the IRS e-file system, which had been running fast most of the season, came to a screeching halt towards the end. E-file confirmations — especially for state returns — at times took almost a WEEK to come back.
• Earned Income Credit. Every EIC claim I filed was legitimate, of course. But every single EIC claim I filed made me nervous. I truly lost sleep over returns with EIC on them, thanks to the new IRS “due diligence” requirements imposed on preparers. I’m beginning to think Robert Flach is right — don’t take on any EIC clients in the future, no matter how legitimate the EIC claim. I’m not sure I’ll do this, but it sounds really tempting.
• Crabby people. Without getting into specifics, it sure seemed to me that many people were just plain crabby this tax season.

I’m curious to know what others thought of the season, whether tax pro or ordinary taxpayer. Am I alone in thinking this was a clunker of a season?

Tax Season 2013: Mostly Unpleasant, And I’m Glad It’s Over is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

Issues

Generally, property settlements in divorce are not taxable. But the federal government doesn’t recognize same-sex marriage — as far as the federal government is concerned, there was no marriage to begin with, so the typical rules regarding divorce and taxes don’t apply. Consequently, divorcing same-sex couples may face both income tax problems (in the form of capital gains) and gift tax problems in property transfers.

Example:

Angie and Alice are in a same-sex marriage in Iowa. They jointly own a house and are both on the mortgage. Angie and Alice get a divorce. The divorce settlement awards the house and the mortgage liability to Angie.

The house’s fair-market value is $160,000. The mortgage balance is $130,000. 

Because their marriage isn’t recognized, it appears that Angie and Alice have a tax problem.

Or do they?

Let’s tackle the gift tax issue first.

Gift Tax

For gift tax purposes, a gift takes place whenever someone gives something to someone for less than full consideration. In this case, it would appear that Alice has given a $15,000 gift to Angie — she’s given Angie a piece of property worth $80,000 (1/2 of the $160,000 value of the home) and received $65,000 of consideration in return (being released of 1/2 of the $130,000 mortgage balance).

$15,000 is above the $14,000 gift tax exemption, so it appears Alice is subject to gift tax on this transfer, right?

Not so fast.

DOMA Can’t Overrule Everything

There is no gift here, because Alice gave up ownership of the house as part of a legal settlement that releases her of her spousal obligations under state law.

The $15,000 difference between the “consideration received” (release of $65,000 mortgage obligation) and Alice’s share of the market value of the home ($80,000) is not a gift. Rather, she is being released of intangible marital obligations under state law. See the 1962 U.S. Supreme Court case of Davis v. United States (the part in parenthesis below is my alteration of a citation within the ruling; the rest is a direct quote):

Any suggestion that the transaction in question was a gift is completely unrealistic. Property transferred pursuant to a negotiated settlement in return for the release of admittedly valuable rights is not a gift in any sense of the term. To intimate that there was a gift to the extent the value of the property exceeded that of the rights released not only invokes the erroneous premise that every exchange not precisely equal involves a gift but merely raises the measurement problem discussed in (a part of the ruling).

Capital Gain

Angie may have a capital gain here, though, depending on what her basis in the property is compared to $80,000. Whether this gain is taxable or not depends on how long Angie owned and lived in the home.

Beware if Truly Unmarried

Angie and Alice are not subject to gift tax because they were married under state law, and the marital obligations were dissolved and property was split in accordance with a court order under state law. This is true even though the federal government doesn’t recognize their marriage.

But if Angie and Alice were truly unmarried, there would be a gift tax issue. This is true regardless of sexual orientation. So this would apply to opposite-sex, boyfriend/girlfriend couples who own property together and then break up and need to split up property.

Same-Sex Marriage, Divorce and Taxes is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times

The IRS still has not processed Brian and Wendy’s final joint tax return for 2010.

Brian and Wendy were native Iowans. After Brian died, Wendy — a widow at age 29 — moved to Texas. The names are real and are used with Wendy’s permission.

You can read the other parts of this series here: 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11,12, 13

—–

As detailed in Part 12, the IRS had said in January that they were finally going to pay Wendy the refund she was owed from the 2010 tax return. The catch was, they were going to knowingly and willingly send the refund check to an old, no longer vaild, address. The check would get sent back to them, and then they would re-issue the check to Wendy’s current address. (The reason why the IRS decided to go about things in this manner is still a mystery.)

The check was supposed to be re-issued in March. March has come and gone, and still no refund check.

I tried calling the “identity theft liason” for Wendy’s case earlier this week. He of course didn’t answer, and hasn’t returned my call. Wendy has tried calling him over the last couple of weeks, and he isn’t returning her calls either.

We did get a notice from the IRS that said the check had come back to them and that we should verify that they have the correct address (they do, and have had it for nearly 18 months).

So I called the number shown on the notice. To my shock, the person at the call center was actually helpful. They’ll be sending a new check — but it will take another 6-8 weeks. The reason for the delay is, the original check was not only sent to the wrong address but was also made out wrong (it included Brian’s name but should have only included Wendy’s name).

To recap the timeline:

• Brian died in January 2010. That’s almost 39 months ago.
• We filed Brian and Wendy’s 2010 tax return right before the filing deadline in April 2011. That’s almost 24 months ago.
• We sent the IRS the requested identity theft forms in the fall of 2011. That’s about 18 months ago.
• The IRS told us we needed to fix a clerical error on the forms in the fall of 2012. That’s about 6 months ago.
• More recent events: in January, the IRS told Wendy that they were finally ready to pay the refund from 2010 but that they were going to mail it to the wrong address. Once the check was “returned to sender,” they would re-issue the check to her correct address “in March.” Now it will be May or June.

Taxpayer Identity Theft — Part 14 is a post from: Home of Jason T. Dinesen, E.A. and The Dinesen Tax Times