IRS addresses state income tax credits

Does your state have refundable credits against its state income tax? What are the federal income tax consequences?

Chief Counsel Advice (CCA) 201423020 specifically addresses the Massachusetts Senior Circuit Breaker Credit. However, the reasoning should apply to similar refundable credits authorized by other states.

In this CCA, the IRS explains the federal income tax consequences of the Massachusetts credit. This credit, which is partially refundable, is payable to qualifying senior citizens who own or rent a principal residence.

The Massachusetts Senior Circuit Breaker Credit is a refundable credit against state income taxes. The credit is available to eligible low-income state residents who paid real estate taxes or rent during the year.

The credit first reduces state income tax liability. If the credit exceeds the person’s state income tax liability for the year, the excess is refunded.

To be eligible for the credit, an individual must:

  • Be an owner or tenant of residential property located in Massachusetts
  • Be age 65 or older
  • Not be a dependent of another taxpayer
  • Occupy the property as his principal residence
  • Meet certain income limits

The CCA concludes that the amount of the credit that reduces a potential state income tax liability as part of computing how much state tax is due is not includable in federal gross income. Instead, it will generally be reflected in a reduced federal deduction for state taxes.

The proper federal income tax treatment of the refundable portion of the credit depends on the tax situation of the taxpayer:

  • A renter who receives the refundable portion of the credit does not include that amount in gross income.
  • A homeowner who claims the standard deduction for federal tax purposes does not include the refundable portion of the credit in gross income.
  • A homeowner who itemized deductions for federal tax purposes in a prior year must include the refundable portion of the credit in income, except to the extent that the prior-year real estate tax deduction did not reduce the federal income tax imposed.