State refund

[L.S.]

Got a notice from IRS re: 2005 federal tax return. It states since we claimed state taxes when we itemized deductions on the 2004 tax return, we must report any refund on the 05 tax return. I completed the worksheet for refunds of amounts deducted in 04 - Line 1 shows our refund of $282 and then for line 2 it says if sales taxes were deducted in 04, enter 0. We did use the sales tax deduction on Line 5 of Sch A. So the worksheet comes out that taxable part of our refund is 0. Am I doing this correctly? Is IRS wrong?

Thanks for your help.

[bstaxes]

I would say you are correct. If you deducted sales tax, you did not take state income tax. The federal is looking for state income tax refund that could be taxable. I have many clienta who use sales tax instead of income tax. Using sales tax would be like not using sch A and getting a refund from state, whether the refund is small or large it is not taxable to the fed. No deduction not taxable.

[kcjenkins]

You are correct, and the IRS is sending out a lot of these. Just respond and show them the worksheet, and that should take care of it.

[L.S.]

Thank you, KC. It is always good to get confirmation that I was correct.

[kcjenkins]

You're welcome. They have been sending out a lot of these, computer generated, of course. You would think they could get this right, since it was clearly reported on the returns.

[joanmcq]

I've gotten quite a few of these. I just send a copy of the previous year Sch A with the sales tax deduction. I get a lot where AMT created no tax benefit too. They are usually easy to clear up.