TurboTax Support Blog

Understanding Those Part-Year Returns

In the Live Community, we are seeing a lot of questions about part-year and nonresident returns. In this blog, I'm going to talk about part-year returns. Since there are many questions on the Oregon part-year return, I'm using Oregon as an example. Just remember that not all states handle their part-year return the same as Oregon but most follow a similar pattern.

Before we get started on the "tax and form" theory, I want to be sure you understand how TurboTax determines that you will be filing a part-year return. As you enter the Personal Info for your 1040 return, be sure you indicate "Yes, I was a resident of more than one state in 2007." And on the "Tell Us About Your Move" screen, enter the date you became resident of your current state and name the state you moved from. With this information, TurboTax determines if you will be answering state questions for a resident or a part-year resident return. For Oregon, the part-year return is Form 40P.

Part-year returns are filed when you've lived in more than one state during a year. Let's say you lived in California for 9 months and then moved to Oregon on October 1st.

Most states will have a two column form. In one column TurboTax enters your income as if you were a resident of that state all year. The other column TurboTax enters the portion of income that was earned or received while you were a resident of that state.

Earned income (wages/self employed income): The income you "earned" while you lived in California is taxed in CA and earned in Oregon is taxed in Oregon. For an Oregon part year return, if the Oregon wages are not separately stated on your W-2 then you can compute the Oregon wages by a ratio of days worked in Oregon over total days worked for the year.

Unearned income (such as interest, dividends, alimony, stock sales, and social security benefits): Unearned income is taxed by the state that you lived in when you received the unearned income. If you sold a stock on April 30, 2007, then that sale is reported on your California return. If you received interest income from your California bank but closed the account when you moved, then that interest goes on the California return.

With those two columns,the state return has your total income for the year and the portion of that income that belongs to that state. Different states will handle adjustments/ deductions/ exemptions in different ways. We'll skip that area.

Now we're down to figuring out the taxes. Most states will first determine the tax as if you were a resident of that state for all year. Let's say that tax is $5,000.

Then there will be a calculation to determine the percentage of that state's income compared to all of your income for the year. Sometime it's the part year taxable income divided by full year taxable income.

The Oregon percentage is determined by dividing Oregon (modified) adjusted gross income by (modified) federal adjusted gross income. The percentage shows up on line 39 on Form 40P.

If your federal adjusted gross income for all of 2007 is $50,000 and $10,000 of that is considered Oregon's income then your percentage would be $10,000/ $50,000 or 20%.

The next step is to multiply that full year resident tax ($5,000) by 20% and the tax you will pay to Oregon is $1,000. Whew! Ain't state taxes fun!

I know this blog has been long and tedious but I do hope it answers some of your questions on your part-year returns.

I work in one state and live in another state. What do I file? (Part II)

I work in one state and live in another state. What do I file?

In Part I, I touched upon the basic principles of income tax reciprocity between states using a fictitious example. In this installment, I will show how state reciprocity is handled for two states that have a reciprocal agreement.

We all know that states like to do things in their own way. It's what makes the United States so...interesting.  Reciprocal rules are no exception.  In some reciprocal states, you just mark a checkbox on your return, fill in a few lines, and you're done.  In other states, well...

Say you live in New Jersey and work in Pennsylvania, two that do have reciprocity. But every year, you end up filing a nonresident Pennsylvania return plus a resident New Jersey return. This is because you earned Pennsylvania source income (your wages) and your home state of New Jersey requires you to report all of your income regardless of where you earned it.

If these two state have reciprocity, then why do you have to keep filing a Pennsylvania nonresident return and a New Jersey return? What's going on?

First of all, Pennsylvania reciprocity rules specify that to avoid filing a nonresident return, you need to submit Form REV-420 to your Pennsylvania employer. This form requests New Jersey state withholding to be taken from your wages, not Pennsylvania withholding.  Second, your Pennsylvania employer needs to grant your request. If and only if both conditions are met, can you only have state tax withheld from New Jersey and not from Pennsylvania. (You'll see the NJ instead of a PA in Box 15 of your Form W-2).

Otherwise your employer is required by law to continue withholding Pennsylvania tax. This means that you will continue to file returns for both states. So you see that reciprocity often comes with conditions; it isn't always automatically granted.

If, you are a resident in one of the states listed below and you are also filing a nonresident return in a reciprocal state, ask your payroll department  or your resident state tax board how you can eliminate the need to file 2 state tax returns.  Usually you just need to fill out a form.  After all, reciprocity is designed to make filing easier, not harder!

Also, see our TurboTax knowledgebase article for the forms that may be required: Filing State Returns When You Live and Work in Separate States.

Here are the states (current as of March 2008) that have reciprocity agreements. The state in bold is your employer state.

• District of Columbia: Allows all nonresidents to exclude DC source income from taxation. However, only Maryland and Virginia have "true" reciprocity with DC (that is, they allow DC residents to exclude MD and VA source income from taxation.)
• Illinois:  Iowa, Kentucky, Michigan, Wisconsin
• Indiana: Kentucky, Michigan, Ohio, Pennsylvania, Wisconsin
• Iowa: Illinois
• Kentucky: Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia, Wisconsin
• Maryland: District of Columbia, Pennsylvania, Virginia, West Virginia
• Michigan: Illinois, Indiana, Kentucky, Minnesota, Ohio, Wisconsin
• Minnesota: Michigan, North Dakota, Wisconsin
• Montana: North Dakota
• New Jersey: Pennsylvania
• North Dakota: Minnesota, Montana
• Ohio: Indiana, Kentucky, Michigan, Pennsylvania, West Virginia
• Pennsylvania: Indiana, Maryland, New Jersey, Ohio, Virginia, West Virginia
• Virginia: District of Columbia, Kentucky, Maryland, Pennsylvania, West Virginia
• West Virginia:  Kentucky, Maryland, Ohio, Pennsylvania, Virginia
• Wisconsin: Illinois, Indiana, Kentucky, Michigan, Minnesota

I Work in One State and Live in Another State. What Do I File? (Part I)

I work in one state and live in another state. What do I file? And what the heck are State Tax Reciprocal Agreements (aka "Reciprocity")?

The first time I tried to say reciprocity, which I assumed was a horrible misspelling of a real word, it came out of my mouth as "reci-pro-whuuaaah?" You know, the Scooby Doo sound. Fortunately, reciprocity is much easier to explain than it is to pronounce.

To illustrate, let's start with an income tax situation involving two states that do not have reciprocity. Joan is a full-time New Mexico resident who works in neighboring Colorado.. Because she earns income in Colorado (us tax savvy types call this “Colorado source income”) her employer withholds Colorado taxes from each paycheck. The fact that she earned Colorado source income also means that she will need to file a Colorado tax return even though she does not live there.

So every January, Joan receives her W-2 form from her Colorado employer, which shows her Colorado wages plus the amount of Colorado income tax withheld from her wages. She sees “CO” in Box 15, the taxable Colorado wages she earned in Box 16, and the total year’s worth of income her employer withheld in Box 17.

New Mexico also requires Joan to file an income tax return because she is a resident and she earned taxable income (they don’t care whether she earned it in Colorado, New Mexico, or Timbuktu). Accordingly, Joan files a nonresident state return for Colorado, where she works, plus a resident state return for New Mexico, where she lives.

Because the two states do not have reciprocity, Joan's income will be taxed by the state it was earned in (Colorado) at Colorado tax rates. On her New Mexico return, she will take a credit for the tax she paid on her Colorado income. (Otherwise, she'll be double-taxed, and that's a no-no.) Now, let's pretend...

... that Colorado and New Mexico have a reciprocal agreement. (They don't! Remember, we're just pretending.) How would that change Joan's filing situation? Well, for starters, Joan’s W-2 would look a little different. Instead of seeing “CO” in Box 15, she’d see “NM”. This means that her employer is withholding New Mexico taxes instead of Colorado taxes on her earnings, even though she is technically earning Colorado source income.

Even better, Joan wouldn't have to file a nonresident Colorado return anymore. She would simply file a New Mexico resident return as if she had earned the money in New Mexico And the reverse would be true for Colorado residents who work in New Mexico.

Oh, and I forgot to mention the best part. Joan no longer needs to purchase TurboTax State software for Colorado -- all she needs is the New Mexico program. Isn't reciprocity great?

This fictional example shows you the basic principles underlying reciprocity. But in real life, things aren't always that simple (yep, you knew I was going to say that sooner or later). So in Part II, coming soon, I'll touch upon a real-life example involving the reciprocal states of New Jersey and Pennsylvania.

Your Vacation Home and Your Tax Return

Have you been thinking about buying a vacation home in the mountains or by the shore?  Are you wondering about how such a home affects our tax return?  Here’s some vacation home info.

The IRS defines your 2nd home as not your primary residence but you use it personally and don’t rent it for more than 14 days per year. This 2nd home can be a condo, mobile home, time-share unit, a boat or recreational vehicle. Remember, per the IRS, like your primary home, the dwelling must include sleeping, cooking, and toilet facilities. See IRS Topic 505 - Interest Expense.

So what do you get to deduct each year on this 2nd home that you don’t rent for more that 14 days?  You can deduct its real estate taxes and mortgage interest that you pay each year on your Schedule A.  Remember that if your mortgages on both homes total more than $1,100,000, there will be a limitation on the amount of interest that you can deduct.  See IRS Publication 936.

When you purchase your 2nd home, you can’t deduct all of the points paid in that year like you did when you purchased your 1st home.  See Deducting Mortgage Points. The 2nd home’s points are deducted over the length of the loan. 

Note: If you own more than one 2nd home (your primary home in New York, your winter home in Florida, and your summer home in Vermont.  – I can dream, can’t I?), you can only deduct the mortgage interest on your New York home and one other home. The mortgage interest on the remaining home is not deductible on your tax return.

You can deduct the real estate taxes that you paid on all of your personal homes. There is no limit.

Like your primary home, you can’t deduct the utilities, maintenance fees etc on your 2nd home.

Let’s talk about when you sell this 2nd home. Often taxpayers think they can take that $250,000/$500,000 exclusion on the gain on their 2nd home. The answer is no. That exclusion amount is only for the sale of your “primary” residence. Your gain on the 2nd home will be taxable on Schedule D and if you have a loss, it’s not deductible. 

There is a way to take advantage of the exclusion; however, you’ll have to do some planning. For example, you sell your primary residence and take the exclusion (see the  Home Sales Tax Webinar for the exclusion rules). Then you move into your 2nd home as your primary residence. You live there for at least 2 years (and meet the exclusion rules) and then sell it. You get to take the exclusion again. (Remember that you can take the capital gains exclusion only once every two years.)

Some folks think that you can exchange your vacation home for another and not pay tax on the gain (like-kind exchange). The courts (T.C. Memo 2007-134) recently ruled that the vacation home couldn’t play the like-kind exchange game since it was not held primarily as an investment. So if you sell your vacation home and buy a new one, it looks like you’ll pay the tax on the gain.

For further information:

IRS FAQ Vacation Home

IRS Publication 17

IRS Tax Topic 701- Sale of Your Home

IRS Pub 523 - Selling Your Home

I’m in the military. Do I need to file a state return?

This question is popping up in Live Community from our military TurboTax customers. For 20 years I was a Navy wife, so I volunteered to try to answer the question.

To figure out which state return an active duty military person files depends (in military terms) on their “home of record” or “state of legal residence.”

First let’s define those two terms.   

Your “home of record” is the state recorded by the military that was your home when you were enlisted, appointed, commissioned, inducted or ordered in a tour of active duty.

Your “state of legal residence (SLR)” is your “home of record” unless you changed it to another state.  Military members often mistakenly think that by changing the state on their paycheck records changes their SLR.  Nope. In order to change the SLR, a DD Form 2058 must be submitted to the finance officer and accepted.

For more information on requirements for valid changes when filing Form 2058, check out a Fact Sheet on Legal Residence that I discovered on Hill Air Force Base’s website. 

From a tax standpoint, your SLR is considered your “domicile” or “resident” state as long as you are on active duty.  Even if you are stationed in another state, you’re still considered a resident of your SLR. 

Now that we’ve defined these terms, let’s look at an example..

Joe lived in San Diego, CA back in 2000 and decided to join the military.  It’s now 2007 and he is stationed in Maryland.  He and his wife Jennifer are living in Virginia.
Does Joe file a state tax return for 2007?  If so, which state?  California, Maryland and/or Virginia?

We know that Joe is considered a California resident (That’s “his home of record” and SLR.)   It depends on each state’s laws if they want their resident military to file a return when they are stationed outside the state.   Let’s see what California law says.   

It says that if Joe is active duty military, home of record is California, and stationed in California, then he files a typical California resident tax return.  If he’s stationed outside of California, he is considered a “nonresident” CA for tax purposes. In most cases, he doesn’t need to file a CA return unless he has CA source income such as rental property income. In these circumstances,  CA source income doesn’t include his military W-2 or intangible income like interest, dividends, stock sales etc. So it looks like Joe doesn’t have to file a California return. 

Remember that each state is different. If Joe’s “home of record” was in a certain state, he may be required to file a return and then deduct all of his income and pay no tax.  That way the state knows he still exists!  And some “home of record” states will tax Joe on his income even if he is stationed outside of the “home of record.”  To check out your “state of legal residence” laws for filing when stationed outside the state, click on IRS’ State Links website to find your SLR’s state website.

Does Virginia or Maryland expect a tax return from him? 

The Servicemember Civil Relief Act states that an active duty member is not considered a resident of a state unless it is his SLR. Joe would only file a Virginia or a Maryland return if he had a nonmilitary 2nd job in that state. If he’s working at Home Depot in Virginia on the weekends, he would file as a Virginia nonresident and only report that W-2.  He would not report any other type of income. 

Answer for Joe: He doesn’t have a rental property back in California and doesn’t work a second job so there is no state return to file for Joe.   

What state return does his wife file?

Joe’s home of record has nothing to do with his wife’s residency.  Like the rest of the nonmilitary world, her residency will depend on which state she lives in and its law.

Let’s say that Joe’s wife is employed in Virginia and lived there all year.  She is considered a Virginia resident who has to file a resident Virginia tax return.

What type of return does she file?  Again each state is different.  The state of Virginia says she files a married filing separate resident state return and includes only her income. 

If they were living in a different state, she might be required to file a nonresident return with Joe. On the return all of Joe’s income would be deducted and only Jennifer’s income taxed. Again, here’s the IRS’ State Links website to check your state on what type of return needs to be filed by a nonmilitary spouse.

For tax year 2007, Joe and Jennifer will file a married filing joint federal return and Jennifer will file a resident Virginia return.

For more information on the military and taxes, read:

Can I Efile with a Foreign Address?

Tax Information for Members of the U.S. Armed Forces

IRS – Armed Forces Tax Guide

New IRA options for military

Reservists and Retirement Withdrawals

Tax Rebates –What’s the Catch?

That’s been a common question from our customers at TurboTax ever since the Economic Stimulus Act became law Feb. 13. It’s not surprising. We’ve all doubtless been warned: “If it’s too good to be true, then it probably is.”  In fact, Google lists 50 million variations of this adage.

Then how could it be true that the government wants to give most of us what is essentially free money? The simple answer is, because the federal government wants to put money in our pockets so we’ll spend it and help stimulate our slowing economy.

Under the act, starting in May some 130 million Americans will receive what’s known to most as a tax rebate. You might hear the IRS call it a stimulus payment. It will be worth at least $300 and as much as $1,200 or more per household this year. Furthermore, it won’t reduce your 2007 tax refund, need to be repaid later, or be taxed in another year. It won’t lower any government benefits you normally get. And if you’re likely to get a stimulus payment, the IRS will send you a letter telling you how you can (you may have already received this). Hint: You have to file a 2007 tax return, even if you don’t normally need to.

So go ahead and get your share. Learn here if you qualify.

Unfortunately, you might not get a rebate if your 2007 income is too high or too low. But, wait, you won’t necessarily miss out. If you didn’t get a payment or got a partial payment because your income was too high or too low, you’ll get a do-over next year. You can use your 2008 income to qualify, when you file a 2008 return in 2009.

Conversely, what if your 2008 return shows you would get you a lower payment than you did with your 2007 return? No worries. Just keep the difference -- really. Also, if you have a baby or adopt a child in 2008, more good news. You could still get a stimulus payment for that child on your 2008 return.

What if you owe federal income tax from a previous year, student-loan debt or back child support? This is where your “luck runs out” (only 372,000 Google listings) because as it does with regular tax refunds, the IRS will turn your free money into a payment of those debts. 

Deducting Mortgage Points

In the Live Community,  lots of people have questions about deducting mortgage points. And I’m not surprised. Like many things in the tax code, there is a lot of confusion around mortgage points because there are a lot variables involved. This blog is written to answer those questions.

What are points?

In short, points refers to interest you pay up front in a mortgage rather than over the life of the loan. They usually allow you to have lower monthly payments. You might see them referred to in your mortgage paperwork as “loan origination fees” or “loan discounts.”

Can I deduct all the points in one year?

As a general rule of thumb, if this is your first mortgage, and you used it to buy or build the home you live in, then yes, you can deduct all the points in the first year. In addition, if you refinance your mortgage, or take out a home equity loan or home improvement loan for the purpose of improving your home, then you can often take the points of those loans off the first year as well.

Of course there are some other rules. For instance, in your paperwork, the points have to be calculated as a percent of your principal, rather than a flat fee. For a full list of requirements, see the IRS Chart on Fully Deductible Points

What if the seller paid the points on my loan?

Sometimes the seller offers to pay the points on a loan. The good news for buyers is that it’s the buyer who gets to take the deduction on the points. The same rules apply about whether you can deduct all the points in the year you paid them as if you paid the points yourself.

Note: the seller cannot deduct the points paid for the buyer; these points are considered selling expenses for the seller.

What if there weren’t enough funds provided to cover the points?

In the convoluted world of mortgage financing, there might be a case, for instance a zero-down payment loan, where points are deducted but then paid for by adding them to the principal of the loan.

The bottom line is that you can only deduct, up front, the points that were actually paid for by you or the seller. Here’s an example:  You were charged $2,000 in points on a new home loan in 2006. The seller paid for $1,000 towards your points and you provided a down payment of $750.  You can deduct fully $1,750 ($1,000 + $750) in points but you must deduct the remaining $250 in points over the length of the loan.

What about a home improvement loan or home equity loan?

In general, you can also fully deduct, in the year paid, points paid on a loan to improve your main home. If the loan is meant for other purposes, like paying for tuition or a car, you can only deduct the points over the life of the loan.

What about the points paid on my second home?

You cannot fully deduct in the year paid points you pay on loans secured by your second home. You still get to deduct these points only over the life of the loan.

What about the points on a refinanced loan?

In general, the points you pay to refinance a mortgage are not deductible in full in the year you pay them. The only exception to this is if you use the proceeds of your refinanced loan to improve your main home.

The good news is, if you’ve been deducting points over the length of your loan, in most circumstances, you can deduct the remainder of the points in the year that the related mortgage is paid off early due to prepayment, refinancing, or foreclosure.

What happens if the mortgage changes hands and I’m deducting the related points over the life of the loan? 

If the mortgage is sold to another lender, there is no change to your tax situation. You need to continue deducting your points over the length of your loan just as before.  Also, you can leave the original mortgage lender’s name to identify those points in TurboTax.

How do I enter my mortgage points in TurboTax?

Select the Federal Taxes tab (at the top of your screen), then select Deductions & Credits. Click on Find Deductions Myself. Under the Home section, click on the Start or Revisit button next to Mortgage Interest and follow the screens.

Can you explain the Home Loan Summary screen in the TurboTax Interview?

The Summary screen shows the information that you entered for each loan. It displays the mortgage interest paid for 2007 and the total points paid with that related loan, regardless if the points are amortized over several years. In the example below, mortgage interest paid for 2007 was $12,000 and the total points paid on that loan was $4,000.

For additional information on mortgage points, see IRS Publication 936

Print a copy of your 2006 tax return. Check Schedule A, line 12 for the amount of amortized points deducted for your 2006 tax return. In the example below, line 10 shows the $12,000 of mortgage interest and line 12 shows $400 as the 2006 amortized deduction of the $4,000 points.