When should a taxpayer claim a credit for taxes paid twice?
Taxpayer Says: Taxes were paid twice on the same income. The double payment should be allowed as a credit when the payment was made.
Internal Revenue Service Says: The overpayment was related to income earned in a prior year, and taxpayer failed to pursue several available courses to remedy the situation. The credit should be disallowed.
From Internal Revenue Code Section 3402(a): An employer is required to withhold Federal income tax from the wages of its employees. TAX WITHHELD ON WAGES. (a) Wage Withholding for Income Tax Purposes. — (1) In general.–The amount withheld as tax under chapter 24 shall be allowed to the recipient of the income as a credit against the tax imposed by this subtitle. (2) Year of credit.–The amount so withheld during any calendar year shall be allowed as a credit for the taxable year beginning in such calendar year. If more than one taxable year begins in a calendar year, such amount shall be allowed as a credit for the last taxable year so beginning.
From Internal Revenue Code Section 31(a): Employees, as recipients of the income being taxed, are allowed a credit for the amount withheld by their employer and can apply it to their tax due (section 31 credit).
From Federal Tax Regulation 1.31-1(a): The recipient of the section 31 credit is the person subject to the income tax imposed upon the wages from which the tax was withheld. However, if a husband and wife domiciled in a community property State make separate returns and, for income tax purposes, each reports one-half of the wages received by the income-producing spouse, then each spouse is entitled to one-half of the credit allowable for the tax withheld.
THE CAUSE OF THE DISPUTE
When your employer withholds income tax on your wages, you claim a credit for those taxes on your personal income tax return, generally in the year the related wages were received.
In this case, the employer of the taxpayer’s deceased spouse was audited in 2004. Under the audit settlement, payments made to the spouse in a previous year (2001) were reclassified as wages, subject to employment tax. The employer paid the tax in 2004, then requested and received repayment for the income tax withholding from the taxpayer. Because the taxpayer had already filed a joint 2001 return that included the income, she effectively paid the tax twice, once to the Internal Revenue Service, and once to reimburse the employer.
In 2005, the IRS issued a notice of deficiency to the taxpayer for the reclassified wages related to the 2001 return. No credit was allowed for the duplicate withholding. The taxpayer did not dispute the notice, and paid the amount shown on the notice in 2006.
In 2007, the taxpayer received a notice of deficiency for her 2004 tax return. When responding to the notice, she claimed the credit for the 2001 double payment because 2004 was the year she reimbursed the employer.
The IRS disallowed the credit, saying it should have been claimed on the tax return for 2001, the year the income related to the tax was earned.
WHAT WOULD YOU DECIDE?
Make your selection, then see “The Court’s Decision” below for a full explanation
THE COURT’S DECISION
HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.
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