08 March 2016 Refundable state tax credits must be included in federal income, Tax Court holds In Rivera, v. Commissioner, a memorandum decision, the Tax Court held that refundable tax credits at the state level are subject to federal income tax (to the extent of the refund received). The taxpayers formed Newburgh Metals, Inc. in 2006 and elected S corporation status. Effective 2007, Newburgh Metals was a certified Empire Zone business under the New York Empire Zone Program (EZ Program). For 2008, petitioners received an EZ Wage Credit of $17,250 and an Empire Zone Investment Tax Credit (EZ Investment Credit) of $58,827. Newburgh Metals qualified as a new business under New York law, and thus petitioners were also eligible to receive 50% of the excess credit as an overpayment of New York income tax to be refunded. Taxpayers did not report any portion of their 2008 New York income tax refund attributable to the EZ Wage Credit and the EZ Investment Credit on their 2009 Form 1040. Taxpayers also received EZ credits in 2010 and 2011 and again did not report the amounts on their Form 1040. In 2014, the IRS issued a notice of deficiency to taxpayers for taxable years 2006, 2009, 2010, and 2011, arguing that refunded EZ Wage Credits and EZ Investment Credits are includible in their gross income. Section 61(a) defines gross income as "all income from whatever source derived". Payments that are "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion" are taxable income unless an exclusion applies. Referencing the guidance in Section 61 and relevant case law, the Tax Court ruled that the refundable portion of an EZ Investment Credit or an EZ Wage Credit is an increase in wealth and must be included in a taxpayer's Federal gross income. While the result of the case is not surprising given that the conclusion mirrors previously released Chief Council Advice, this adds to a mounting set of precedent around the federal tax treatment related to transactions involving refundable state tax credits. This case illustrates that many companies are either unaware of the precedent and/or are continuing to take aggressive tax positions. This case issues a warning to such taxpayers.
Document ID: 2016-0468 | |||||||||||
