MA Senior Circuit Breaker Credit - Is It Taxable on the Federal 1040 Return?

Under certain circumstances, MA allows a refundable credit to Senior Citizens who are burdened with high cost (in relation to their income) rent payments or local real estate tax payments. If you meet the requirements as to maximum total income and assessed value of the real estate, a taxpayer may qualify for up to a maximum refundable credit of $1,030.

As reported previously, there is an issue as to whether or not this refundable credit is reportable as federally taxable income because it may represent a refund of real estate tax paid (and previously deducted as an itemized deduction on Schedule A).

Now comes the IRS (see Chief Counsel Advice 201423020) which analyzes the way in which the credit is computed and paid. It concludes that the amount of the circuit breaker credit which reduces the state income tax liability is NOT includable in federal gross income, under the theory that such a state credit against a state income tax will generally reduce the federal itemized deduction for state tax under Sec. 164. However,
this creates a timing difference in how a Schedule A deduction is actually calculated.

Consider this:

W-2 wage report for 2013 includes $3,000 of withheld MA income tax. No other tax paid. MA return for prior year included an underpayment of $200. Total deduction for state tax paid in the current tax year - $3,200. Now, let’s throw-in a calculated circuit breaker credit of $400 on the MA return. Should the $3,200 federal deduction be changed? Answer: NO. Taxpayer is cash basis. A credit calculated and used in 2014 does not change the tax paid in 2013.

Now comes 2014. Same $3,000 of withheld MA income tax. No other tax paid. MA return for 2013 shows liability of $3,500, payments of $3,000 and circuit breaker credit of $600 – resulting in a refund of $100. The CCA concludes that the 2014 federal itemized deduction should be $3,200 ($3,000 withheld plus $200 balance due paid in 2014) less $100 for a net of $3,100. It ignores the non-refunded portion of $300 which was applied against the balance due before credits.

Furthermore, this reasoning applies only to a situation where the homeowner taxpayer itemizes for federal purposes. It neither applies to a rentpayer taxpayer nor to a homeowner who does not itemize for federal purposes. When applicable, the CCA states that the reportable amount (see $100 above) is reported on Line 21 of Form 1040 (i.e. not as a net on Schedule A). However, if reported in this manner, the taxpayer will eventually receive a notification from the Mass. Dept. of Revenue that the state income is under-reported by the amount shown on Federal 1040, line 21. This is a result of matching (or trying to match) information exchanged with the IRS against income reported on MA Form 1.

Therefore, your editor recommends that the amount be netted on Federal Schedule A, since this will avoid a federal/state discrepancy notice from MA, while it is unlikely to create a federal notice.

See the CCA for an explanation of the IRS reasoning in applying the applicable tax benefit rule. It is your editor’s opinion that their reasoning is tenuous at best, in that they view the assessment and collection of local real property tax as granted to the local government by the state. Therefore, they reason that the state is not an unrelated third party (if the state were an “unrelated” third party, the tax benefit rule would not apply). In our assessment scheme, the state reviews and certifies the local assessed values. Once this annual approval and certification is issued, the local taxing entity then may issue a final tax rate (having previously billed using an estimated rate if the approval process is not timely). Thus, reasons the Chief Counsel’s Office, the state has sufficient control over the process so that it is part of the process of assessing and calculating (for purposes of real estate tax and senior circuit breaker credit calculation). It’s a stretch, indeed, in your editor’s opinion.