Bill to end double taxing proved too costly to pass

When Rhode Island lawmakers streamlined the state income tax code three years ago, they built into it a feature that accountants say doesn’t make much sense: taxing refunds.
Described as an “oversight” of the overhaul by some lawmakers, this change in the code causes many taxpayers who itemize their deductions to be taxed twice on a portion of their income.
If state leaders didn’t intend the change as a stealth tax increase and just stumbled into it, they haven’t rushed to provide any relief.
A bill that would have eliminated the taxation of refunds died in the House this summer and was dumped in a study committee before the end of the legislative session.
Why did lawmakers not fix something many believe is a mistake? It raised more than $12 million in additional taxes last year and the Senate Fiscal Office predicted that fixing it would cost the state budget $13.4 million in fiscal 2014 and $14.1 million in fiscal 2015.
“There was a fiscal impact and obviously at the end of the session the shortfall in the state budget was bigger than expected and unfortunately it didn’t pass,” said Sen. Michael J. McCaffrey, D-Warwick, sponsor of the fix bill. “It is not fair at all to those taxpayers who are being double taxed.”
The taxation of refunds began when Rhode Island ended itemized deductions for state income tax.
On their federal tax return, those who claim state taxes as a deduction have to offset it against any refund they received from the previous year.
State personal income tax forms start with federal adjusted gross income and in the past state itemized deductions allowed the taxpayer to re-deduct the state refund.
Since itemized deductions went away, there has been no way to re-deduct the state refund. As a result, the money you got back from the state because you paid too much in taxes the previous year is added to your income and you get taxed on it again.
“It is inequitable, because you didn’t get the benefit of the deduction in the first place, but they are going to tax you on it,” said David C. Morganelli, a tax lawyer at Partridge Snow and Hahn LLP in Providence and chairman of the tax committee of the Rhode Island Society of Certified Public Accountants, which has led the charge for the fix. “It’s an issue of fairness and when you make it a [fairer] tax landscape, you will attract residents and make it a more desirable place to be,” Morganelli said.
Although the Senate Fiscal Office projects the amount captured by the tax to increase this year and next, the fact that more accountants and taxpayers have become aware of the issue may work against it.
After all, like many tax features of the tax code, there are ways to avoid the refund tax: lower the amount you withhold in state income tax so you never get a refund to begin with, says Morganelli.
The Rhode Island study commission looking at the itemized-deduction-changes question can examine how other states treat refunds.
In Massachusetts “refunds of U.S. and Massachusetts income taxes are not considered income,” according to the Massachusetts Department of Revenue website.
The R.I. Division of Taxation has not made a recommendation on whether the current system is ideal and will enforce whatever policy is set by the General Assembly, said Taxation spokesman Neil Downing.
McCaffrey’s bill, which was sponsored in the House by Rep. Joseph M. McNamara, D-Warwick, would have allowed taxpayers to subtract state income tax refunds from the federal adjusted gross income they include on their state return.
Despite the attention of accountants, the refund question came to the General Assembly relatively late in the year and was certainly hurt by the fact that low tax collections had created a $70 million budget gap.
The study commission will have six members and is supposed to report its findings by Feb. 5 of next year.
McCaffrey appears to have support in the Senate, where the bill passed and is backed by Senate President M. Teresa Paiva Weed.
Its prospects are murkier in the House, where Speaker Gordon D. Fox is undecided on the issue.
“The question he has is whether or not Rhode Island can afford what may be recommended,” said Fox spokesman Larry Berman in an email. “He’ll reserve judgment until the commission completes its work.” •

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  1. Of course for Gordon Fox FAIRNESS is a non-starter. No wonder people bail on Rhode Island. How about government wastes less and the revenue hit is offset by honest dealings? Whoops! Not here in little Ol’ Rhode Island.