How to Properly Calculate Taxability of a Federal Refund on Your Iowa Taxes

Residents of Iowa are taxed on their federal tax refunds. This is a primary complaint I hear from clients, especially people who have moved here from other states that don’t engage in this practice.

The full amount of the federal refund is not always taxable. In true Iowa tax fashion, you must perform recalculations. Yay! And also in true Iowa tax fashion, there might be times when you receive a federal refund but can actually take a deduction for federal taxes paid, instead.

Math Class is in Session

To figure how much of your federal refund is taxable, you have to look at your prior-year federal return to see if you claimed any refundable credits. For example, the Earned Income Credit, Making Work Pay Credit, Additional Child Tax Credit, Adoption Credit (for 2010 and 2011 only), etc. Basically, any credit that appears in the “Payments” section on page 2 of Form 1040.

Iowa does not tax you on refundable credits received. So you have to perform calculations to determine what to put on your Iowa return.

Example:

Joe received a federal refund of $1,000 in 2010. Included in this amount was a $400 Making Work Pay Credit (a refundable credit). Iowa will tax Joe on $600 of his refund ($1,000 minus $400) on his 2011 tax return.

This can result in you getting to take a deduction for additional federal taxes paid, even if you got a federal refund.

Example:

Joe received a federal refund of $300 in 2010. This included a $400 Making Work Pay Credit (a refundable credit). Joe can take a deduction of $100 on his 2011 Iowa tax return ($300 minus $400).

Notes

  • You use your prior-year federal refund amount, not your current-year refund amount (so you will use your 2010 refund amount on your 2011 Iowa return).
  • Essentially, Iowa only taxes you on the amount of federal refund attributable to excess federal withholding. This is because Iowa allows a current-year deduction for federal taxes paid. If you receive a refund because of too much withholding, Iowa “recaptures” the excess the following year.

Image: photostock / FreeDigitalPhotos.net

“This blog post, along with comments that may follow, should not be considered tax advice. Before you make final tax or financial decisions, please secure a professional tax advisor to give you advice about your unique situation. To secure Jason as your accountant, please click on the ‘Services’ link at the top of the page.”

7 Responses to “How to Properly Calculate Taxability of a Federal Refund on Your Iowa Taxes”

  1. Jerry February 27, 2012 at 10:54 am #

    Every year I puzzle over this Step 6 on the Iowa return. It’s a mess because one spouse has only wages and one has only self-employment income. Throw in both self-employment taxes and federal credits like the American Opportunity (college) credit, and I can’t tell what I paid? Did I “pay” the college credit of $1000 or the Making Work Pay credit, or the child care credits?

    • Jason Dinesen February 27, 2012 at 10:59 am #

      Jerry,

      Wow, that makes my head hurt! I’m going to toss that scenario around in my mind.

    • Jason Dinesen February 27, 2012 at 11:20 am #

      This is just my “top of the head” thought on a Monday morning, but — I think you take the total federal refund received in 2010, subtract out the college credit and Making Work Pay, and then allocate whatever federal refund is left based on you and your spouse’s Iowa net incomes for 2010 (if you itemized deductions in 2010, your percentage of net income would be at the bottom of your 2010 Iowa Schedule A). So if you had 60% of the income, you would claim 60% of the refund on your side of the Iowa 1040 and your spouse would claim 40% on their side. Aren’t Iowa taxes fun? Good luck!

      • Jerry February 27, 2012 at 12:28 pm #

        Iowa taxes are crazy difficult. Having to file separately and having to divide various item according to our respective income shares are also hard to do after the simple federal method.

        I never get a refund since I don’t pay estimated taxes ahead of time and always have the big social security payment to make.

        But that step 6! If they could link me to specific lines of the federal 1040 that would help. But then there’s that “if” clause in line 28 directions which makes it seem like I could choose to describe my federal taxes paid in various ways (with or without my self-employment taxes portion). And it doesn’t distinguish between my employer’s half of my self-employment tax and my employee’s half of the tax. I pay both halves, of course, but one half was deducted back on Schedule F. Do I have to put it back on again? Apparently. Grrr.

        I’d be willing to get rid of federal deductibility just to make the form understandable. I suppose I could refrain from attempting to deduct my federal income taxes, but I don’t see that (expensive) option discussed in the directions.

        • Jason Dinesen February 27, 2012 at 6:50 pm #

          There was a proposal in the legislature, in 2009 I think, that would have eliminated the deduction for federal withholding, which would solve the whole issue of taxability of refunds. No deduction for withholding would mean there would be no need for refunds to be taxed. Unfortunately the proposal didn’t get far.

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