State tax refunds may be a surprise victim of the federal "fiscal cliff."
Federaland state tax systems are so intertwined that taxpayers will find itnearly impossible to file a state tax return - or get a timely refund -until Congress resolves the current fight over tax policy.
Mostof the fiscal cliff fight involves tax rates for 2013. That doesn'taffect your ability to file this year's return. But Congress also needsto retroactively settle a few 2012 tax issues - deductions, credits andthe Alternative Minimum Tax (AMT). Until this is done, it will be hardto file either a federal or state tax return.
Forty-one statesand Washington, D.C., have income taxes, collecting $300 billion in2012. All of these governments have finished their rules, set rates andare ready for taxpayers to file.
Abouttwo-thirds of state income tax filers get a refund. The amounts aresmaller than the average federal refund of $2,707 last year, but stillsubstantial: an average of $1,146 in Maryland, $831 in California and$314 in Ohio.
For simplicity reasons, nearly every state uses"federal adjusted gross income" as the starting point for computingstate tax liability. With federal tax law up in the air, how to computethat crucial number - what goes on Line 37 of the federal 1040 form -will remain a mystery to many taxpayers.
"Theoretically, you canfile state and federal returns separately. In reality, the two systemswork in concert with each other, so it's hard to separate them," saysHarley Duncan, managing director of state tax issues at KPMG, a taxadvisory firm.
Tax preparer H&R Block is encouraging clientsto wait to file state and federal returns together, says Mimi Nolan,director of the company's Tax Institute. TurboTax has created a "redlight/green light" system in its software to tell users if, in theestimation of TurboTax's 150 tax analysts, it's OK to file a statereturn before federal law is set.
"Tax refunds are the biggestpayday of the year, bar none, for 60 million people living paycheck topaycheck," says TurboTax Vice President Bob Meighan. "This money iscritically important to people paying rent, paying down debt and otherexpenses."
But tax law is so complicated that even the 96% oftaxpayers who don't use the deductions currently being debated can gettripped up on unsettled issues, such as whether the sales tax can be anitemized deduction and the AMT.
Some examples of state returns and refunds thwarted by the current debate:
•Many states require attaching completed federal tax forms to statereturns. Example: North Dakota requires the federal 1040. New Mexicowants Schedule A. New Jersey wants Schedule B. New York wants SchedulesC, D, E and F.
• The IRS runs the electronic filing system used bystates and 80% of taxpayers. The IRS is supposed to start acceptingfederal and state electronic returns on Jan. 22. If Congress doesn'tact soon on the AMT, the IRS will need until March to reprogram itse-file computers - a delay that would block millions of state returns.
"TheAMT is the bug-a-boo," says Verenda Smith, deputy director of theFederation of Tax Administrators, a coalition of state tax collectors.States don't use the federal AMT to compute taxes, but they rely on thefederal electronic filing system to be at full speed during the peakfiling period in mid-February.
"Our state return is indivisiblefrom the federal return," says Gary Gudmundson of the Ohio Department ofTaxation. "It's not like you can do one without the other."