Is earned income credit taxable?

[new2freeadvice]

What is the name of your state (only U.S. law)? NJ

I received a refund from filing an amended state return. Included in the refund amount is the state earned income credit. I'm doing my own taxes online and currently completing my federal return. One of the question is how much refund did I get from the state. Do I report the entire refund or subtract the EIC from it?

 

[LdiJ]

What is the name of your state (only U.S. law)? NJ

I received a refund from filing an amended state return. Included in the refund amount is the state earned income credit. I'm doing my own taxes online and currently completing my federal return. One of the question is how much refund did I get from the state. Do I report the entire refund or subtract the EIC from it?

Did you itemize federal deductions on your last year's return? If you did not, then your state refund would not be income for this year. If you did itemize deductions then the entire amount of your state refund is income for this year.

Here is why:

When you itemized deductions by filling out Schedule A on your federal return, you got to deduct all of your state (and local if you have local taxes). Your state refund was not taken into consideration. Therefore, if you got a refund you got a bigger deduction than you were entitled to receive. However, since you got the money in 2013, it becomes income for 2013.

However, most people who receive EIC don't have anything to itemize, therefore its fairly unlikely that your 2012 state refund would be taxable for 2013.

This is also a prime example of why I don't like online tax software. Its all question and answer format and since no one reads the IRS instructions when they use online software, they answer lots of questions wrong. Sometimes its because the questions are not clear, but sometimes because they don't know that they should say no, rather than yes.

I spend a goodly amount of time between April 15th and about December 1st each year fixing mistakes people have made using online software. Its not uncommon that I cannot figure out what they did to cause the problem in the first place.

There used to be some good online software that was not question and answer format where people had to actually read the instructions in order to do their taxes properly. Those programs were more similar to the types of professional software that I am accustomed to use.

I will never forget one tax season about 12 years ago. It was the year that I decided that I would rather work for someone than spend the money to buy professional software myself. Since I was new at the firm I didn't feel comfortable doing my own return at the firm...so I decided to use the most well known (and still is the most well known) online software. I had something fairly simple to do on my return. I needed to take a penalty exclusion for some of the money I had taken out of a retirement account that year. I had done the return by hand already, so I knew exactly what the numbers should be. I could NOT, no matter what I did make the online software do it correctly. I ended up with this circular problem where when I would get one form to produce the correct numbers, it threw off other forms. Finally I just gave up and did my return at work.

Ever since then any friend or family member that asks me about using online software I tell them to do the return first, by hand, following the IRS instructions. Then, if the software doesn't produce the right result, I tell them to check their math, and if their math is good, to try another program.

 

[new2freeadvice]

I understand the need to report the state tax refund but I am referring to EIC portion of the refund. The EIC amount is not on the original tax filing. The check that I received from the state included a refund of my tax overpayment, interest overpayment, and EIC.

BTW, I did itemized.

 

[LdiJ]

I understand the need to report the state tax refund but I am referring to EIC portion of the refund. The EIC amount is not on the original tax filing. The check that I received from the state included a refund of my tax overpayment, interest overpayment, and EIC.

BTW, I did itemized.

Then you need to report the entire state refund as income for 2013...you might have an exception if the EIC amount made your state refund larger than the itemized deduction that you claimed, but otherwise the whole thing is income for 2013.

 

[new2freeadvice]

I guess I am missing the big picture here. I need to report the "tax" portion of the refund (as income for 2013) because I deducted too much on the original return. According to the above post, I should also report the EIC as income. Thus, there is a possibility that I may have to pay tax on the EIC amount. What is not clear to me is that "if" I was able to use the EIC to reduce my tax liability on my original return, I would not have any EIC to report for 2013 and no possibility of being tax. In both cases, I receive the benefit of a refundable EIC but one is taxable.

 

[davew128]

I guess I am missing the big picture here. I need to report the "tax" portion of the refund (as income for 2013) because I deducted too much on the original return. According to the above post, I should also report the EIC as income. Thus, there is a possibility that I may have to pay tax on the EIC amount. What is not clear to me is that "if" I was able to use the EIC to reduce my tax liability on my original return, I would not have any EIC to report for 2013 and no possibility of being tax. In both cases, I receive the benefit of a refundable EIC but one is taxable.

1) You are correct in your question. You're not applying something called the tax benefit rule which for this purpose is way too complex for me to type out without my hands cramping. That said...
2) How is it you think its applicable in this instance, since in order to get the state EIC, you had to have the federal EIC. I can barely think of any instances where someone would get the federal EIC, itemize, and have a taxable state refund in a state that DOESN'T have a state EIC.

 

[davew128]

Then you need to report the entire state refund as income for 2013...you might have an exception if the EIC amount made your state refund larger than the itemized deduction that you claimed, but otherwise the whole thing is income for 2013.

EIC is specifically not income regardless of anything else. That said, I am having a hard time believing the right questions and answers are being asked here, and I don't mean you and I.

 

[new2freeadvice]

NJ do have EIC. It is 20% of the federal EIC. Yes, I am eligible for federal EIC. I itemized on my original return, but when I amended my 2011 federal return last year because of a disability ruling, I became eligible for EIC. NJ also determined that I was entitle to EIC and send it to me together with my tax refund in one lump sum.

I googled the tax benefit rule. Basically, the main principle is that if a taxpayer recovers a sum of money that should have been paid in the past, they must pay tax upon it if it was not counted in their taxable earnings in a previous year. I understand this is why I need to report "tax" portion of the refund but how does this apply to the EIC? I did not claim the credit on the original return. Again, my confusion regarding EIC is stated in my previous post.

 

[davew128]

I googled the tax benefit rule. Basically, the main principle is that if a taxpayer recovers a sum of money that should have been paid in the past, they must pay tax upon it if it was not counted in their taxable earnings in a previous year. I understand this is why I need to report "tax" portion of the refund but how does this apply to the EIC? I did not claim the credit on the original return. Again, my confusion regarding EIC is stated in my previous post.

That is NOT what the tax benefit rule is. It states the recovery of an amount deducted in a previous year will not be income if you did not receive a tax benefit from the deduction in the first place. If your income tax would have been zero in the deduction with or without that tax deduction, you didn't get a tax benefit.

 

[LdiJ]

NJ do have EIC. It is 20% of the federal EIC. Yes, I am eligible for federal EIC. I itemized on my original return, but when I amended my 2011 federal return last year because of a disability ruling, I became eligible for EIC. NJ also determined that I was entitle to EIC and send it to me together with my tax refund in one lump sum.

I googled the tax benefit rule. Basically, the main principle is that if a taxpayer recovers a sum of money that should have been paid in the past, they must pay tax upon it if it was not counted in their taxable earnings in a previous year. I understand this is why I need to report "tax" portion of the refund but how does this apply to the EIC? I did not claim the credit on the original return. Again, my confusion regarding EIC is stated in my previous post.

There are two things that you need to look at...

First, did itemizing do you any good? Did you receive a bigger refund because you itemized? If itemizing did not do you any good, then the state refund is not going to be taxable.

Second, if itemizing benefited you, then you need to look at the amount of the state tax refund you received compared to the amount of state tax that you deducted. If the refund is bigger than the amount of state tax that you deducted, then the taxable amount would be limited to the amount you deducted. If the amount you deducted is bigger than the amount of the refund, then the full refund is taxable.