• 21 Feb 2012

Past Returns Play Greater Role in Present U.S. Tax Return Preparation

Thomson Reuters Senior Tax Analyst Points Out What to Look For on Past Returns to Complete 2011 Tax Returns

This tax season, more information than ever from earlier tax returns may be required to fill out the current return, said Bob D. Scharin, Esq., a senior tax analyst for Thomson Reuters. Various lines on the 2011 version of Form 1040 are affected by tax return entries made for 2010 or even earlier years. Scharin described six common situations below:

  1. Roth IRA conversion. Taxpayers who converted traditional individual retirement accounts (IRAs) to Roth IRAs in 2010 were entitled to tax deferral, with the taxable part of the conversion reported half in 2011 and half in 2012. These taxpayers need to consult their 2010 returns to determine what to report on their 2011 returns.
  2. Energy credit. In 2011, taxpayers are entitled to claim a non-business energy property credit of up to $500 in connection with expenditures for certain energy-efficient home improvements, such as a 10 percent credit for insulation, exterior doors, and (subject to a $200 maximum) windows. Among the restrictions that apply to this credit, the $500 maximum is reduced by any non-business energy property credit claimed since 2006. Consequently, taxpayers who took advantage of the credit in those earlier years need to check the applicable tax returns to determine whether they may claim a tax credit in 2011 for any of their otherwise-qualifying expenses.
  3. First-time homebuyer credit. The 2008 incarnation of the first-time homebuyer credit was actually an interest-free loan. It must be repaid in 15 equal annual installments, beginning with the 2010 return. Someone who claimed the maximum credit of $7,500 needs to repay $500 on the 2011 return. Furthermore, someone who claimed the credit in 2008 through 2010 and then sold the home in 2011 must report as income, on the 2011 return, the not yet repaid credit to the extent of gain from the sale of the home. In figuring gain, the cost basis of the home is reduced by the not yet repaid credit.
  4. Capital loss carryover. This long-time reason for reviewing last year’s tax return is more prominent following years of stock market turmoil. Taxpayers may use capital losses to offset capital gains plus up to $3,000 of ordinary income annually. Excess net capital losses are carried forward to the later year, at which time they may be used in the same fashion. So, someone who reported excess net capital loss on the 2010 tax return may use it to achieve tax savings on the 2011 return.
  5. State income tax refund. A perennial question involves whether a state (or local) income tax refund is taxable. The answer depends on whether the taxpayer received a tax benefit when the refunded amount was originally paid; the past year return is needed to figure this out. This means that a refund of a 2010 state income tax overpayment that was refunded in 2011 is taxable as 2011 income only if the taxpayer itemized deductions in 2010 and even then only to the extent that the total itemized deductions exceeded the standard deduction. The computation becomes more complex for those who paid alternative minimum tax (AMT) in 2010.
  6. IRA distribution. Contributions to traditional IRAs can be deductible or nondeductible. Withdrawals are tax-free to the extent they represent a return of the nondeductible contributions. This calculation depends on not just the aggregate nondeductible contributions made, but also on how much of previous IRA withdrawals was reported as tax-free. The necessary information is on the last tax return on which IRA distributions were reported (i.e., the 2010 return for those taking annual distributions).

“With all these reasons for retaining past year returns, taxpayers may wonder how long they need to wait before safely discarding any of the accumulating stack of papers,” said Scharin. “This question has no simple definitive answer that applies in all circumstances.” The general rule is to retain tax returns for six years from their required filing deadline. However, that may not always be sufficient. For instance, someone with a nondeductible IRA may have taken a distribution at age 60 and then not taken another one until age 70-½. “That person would need to consult the tax return for the year of the first withdrawal to compute the correct tax on the later one.”

Taxpayers should consult with a personal tax advisor before applying these or other tax strategies.

Up-to-date analyses of legislation and regulations affecting individual taxpayers are available to tax and accounting professionals on the industry-leading, award-winning Thomson Reuters Checkpoint research platform.

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