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.