Even tax returns that are professionally prepared often have errors and omissions that may cause you to miss out on some valuable deductions. Having just made it through the 2016 tax season I want to share some of the common errors and omissions I see when reviewing tax returns. The state-specific issues relate to New Jersey, New York, and Minnesota, the three states where most of my clients reside. If you think something may have been missed on your return, it is not difficult to prepare and file an amended return.
I’ll start with Medical Expenses since this is the most common omission I see. This relates specifically to New Jersey. New Jersey allows for a Medical Expense deduction in excess of 2% of Adjusted Gross Income (AGI) in contrast to the Federal level where the threshold is 10% of AGI (7.5% if over age 65). The primary reason this deduction is missed is that many people do not realize that the medical and dental premiums paid through their employer are taxed in New Jersey and are thus deductible. This differs from the Federal level where medical premiums paid through work are a pre-tax deduction and thus can’t be deducted on Schedule A. If you compare your New Jersey income on your W2 with your Federal income, New Jersey’s is usually higher. One of the reasons is that medical premiums are taxed. For most people, the premiums alone will exceed New Jersey’s 2% threshold, and any out-of-pocket expenses incurred just add to the deduction. Contributions to a Health Spending or Flexible Spending accounts are also generally taxed by New Jersey so any distributions from those accounts can be deducted. New York and Minnesota do not allow deductions for medical expenses but do allow a deduction for premiums made for Long-Term Care.
New Jersey’s W2 income is also higher than the Federal W2 income because New Jersey taxes public sector employee contributions to 403b, 457, and 414h. The state at one time proposed a tax on 401K contributions as well but caved after the big corporations threatened to leave. Thus, if you are in one of the retirement plans taxed by New Jersey it is important to track your contributions to these plans so that you don’t pay tax a second time when you make a withdrawal. If you think you may someday move to a different state that taxes retirement income, you will want to track not only the contribution made but also the tax paid on those contributions. Other states will not allow you to exclude the retirement income. They will only allow you to take a credit for tax paid to a different state. I track contributions made and taxes paid for my clients who are impacted by this.
Minnesota has a unique deduction that I have seen missed. Minnesota allows a deduction of up to $2,500 for educational enrichment expenses such as music lessons, tutoring etc.
A deduction I have seen confusion around is personal property taxes. To deduct personal property taxes on Federal Schedule A, the tax must be based on the value of the personal item. The most common personal item that is taxed the automobile.
In Minnesota, the auto registration tax is based on value, and thus most of the tax is generally deductible, but in New Jersey the car registration tax is based on the weight of the vehicle and is thus not deductible.
What I have seen missed relates to the real estate tax deduction when some of the real estate tax is paid at closing when purchasing a home. This will not show up on the Form 1098 received from the bank. You’ll need to review the closing documents to identify any tax paid.
To maximize your deductions, keep good records of non-cash charitable donations. The IRS allows you to deduct the fair value of donations of clothes or household items but requires good record keeping. Goodwill publishes a guide to valuing these items. The value of these contributions can add up, especially if you are moving. In our house we keep a sheet of paper taped to the wall in the basement near the bags of clothes to be donated, and we mark off everything we put into a bag. Another good idea is to take a photo of what you donate.
An income exclusion that I see missed that impacts most if not all states is interest on U.S. government securities, which for the most part are not taxed at the state level. This impacts bond funds held in a taxable account. If a portion of the fund dividends reported on a Form 1099 DIV received from a brokerage firm relates to U.S. government securities, you can exclude that income on your state return. Fund companies publish reports that indicate the percentage of income from U.S. government securities generated by each of their bond funds. You can find these reports on the fund company website. Tax preparers often fail to take the extra step to calculate this.
Another report published by mutual fund companies is the percentage of Federal tax-exempt income by state. Most states do not tax income generated by their own bonds but do tax generated by the bonds of other states and local governments. Thus, you can exclude from income on your state return Federal tax-exempt income related to bonds from your home state.
You will also want to check how your state refund from the prior year is handled on your current year return if you paid Alternative Minimum Tax (AMT) in the prior year. For the most part, if you itemize deductions, a state tax refund will be included in income on your Federal return the following year. But state and local taxes are not deductible in the AMT, and thus any refund would not be taxable the following year (unless the amount of the refund was enough to get you out of the AMT, which is unlikely). Many tax software program default to including the refund in income the following year.
Finally, New Jersey has a couple of exemptions that are different from federal exemptions. The first is for a disability (the additional Federal exemptions are for those over age 65 or blind). The second is for a student in college. But keep in mind that this exemption is only up to age 21, unlike the Federal dependent criteria, which allows for a college student up to age 24.
Please contact me know if you have any questions.