Should You Be Paying Your 2018 State Income Taxes Today?
The author makes a case as to why payments in 2017 of state tax liabilities projected for 2018 are not deductible on a 2017 federal income tax return.
After the 11th hour enactment of the new federal tax legislation, some commentators and tax practitioners are suggesting that — in view of the elimination of the state income tax deduction for 2018 and subsequent years — individual taxpayers prepay their 2018 state income tax liability and claim the deduction on their 2017 federal income tax returns.
Aside from the problem that many high-income taxpayers will find benefits significantly limited because they will face the alternative minimum tax (which will not apply to as many taxpayers in 2018), I believe there is scant authority, if any, in federal tax law to support deductibility of a prepayment of tax for a year that has not yet arrived.
News reports and commentators have cited the IRS (Rev. Rul. 71-190 and Rev. Rul. 82-208) as the basis for claiming a 2017 deduction for payments made in 2017 to be applied to a tax liability in 2018, a year that has not even arrived yet, let alone produced any income, deductions, credits, or other items to support a tax calculation. Any payment might be in the form of an estimated tax to be credited against the 2018 tax liability when it is determined. Wisconsin even has a form for making a payment in advance.
However, the revenue rulings cited in the media do not address this type of situation. What has been addressed is a payment of taxes very late in a given tax year — for example in 2017 — with respect to that tax year (i.e., 2017 in this example). In fact, the latter ruling held that the payment was not deductible because the taxpayer had no reasonable basis to believe they owed additional state taxes and was apparently only attempting to reduce their federal tax for the year at issue.
Where there is no liability yet in existence, the payment of an excessive 2017 estimated tax payment would be applied against a future liability that is not limited in duration. There is no certainty, for example, as to whether the taxpayer would exist in order to recognize the income. The taxpayer may die in an accident early in 2018 before recognizing any income. It cannot be said there is a liability for state income tax beyond Dec. 31, 2017.
In interpreting authorities, the IRS and the courts apply the concept of “substance over form.” This would be particularly true with regard to treating an item in a way that Congress did not intend for the item to be treated.
I believe that payments in 2017 of state tax liabilities projected for 2018 are not deductible on a 2017 federal income tax return. There is simply no authority for that position, and Rev. Rul. 82-208 is actually authority against that position. A payment sent to a state or local government before 2018 to apply against 2018 tax liability is a mere deposit. Tax deductions are not available for deposits (Rev. Rul. 79-229).
Having practiced accounting for more than 35 years, I am pleased that taxes are a hot topic in the media. Accountants haven’t been this popular since … well, we’ve never been this popular.
The best advice is to have your tax practitioner explain the reasoning behind a tax position to you, and make certain that you are comfortable with it. The amount of tax savings for a prepayment, even if it is in the thousands, will seem very small in the face of the cost of a tax audit.
Mitch Reitman, a SSI Hall of Fame inductee, is the Managing Principal at Reitman Consulting Group. He can be reached at (817) 698-9999.
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