How to Double Your State Income Tax Without Really Trying

Originally Published on forbes.com on December 14th,2011

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Charles and Susan Van Ness sold some California real estate realizing a capital gain of $425,000 in 2005.  They reported the gain on both their federal and state income tax returns.  Although, that seems thorough, it is not quite thorough enough.  The couple were residing in the State of New York in that year so they were required to also file a California non-resident return.  The California non-resident return would have cost them some extra tax.  The California tax on the gain was about $34,000.  Not surprisingly California caught up with them eventually.  What with interest and penalties they had to pay over $43,000.

Of course they were entitled to a credit on their New York state income tax.  That happened to work out to about $28,000 (States generally allow you a credit for the lesser of what you paid another state on income sourced to that state or the amount that your home state charged you on that transaction.)  Their tax consultant prepared an amended return which Mrs. Van Ness mailed in January of 2009.  Perhaps because there was plenty of time left on the three year statute of limitations, she did not bother to get a return receipt.  At this point coincidence started to play an ugly role.

There had been an apparent mismatch between income reported by the IRS to New York and what appeared on the Van Ness New York return.  It was in the amount of $7,000 – not that big a deal - and the couple was able to clear it up resulting in a no change report in October 2009.  The coincidence problem was that when Mrs. Van Ness received a notice from the state that they had received her correspondence and were working on it, she thought they were referring to the amended return.  Actually they were writing about a response to the mismatch notice.  The state never received the amended return – or at least has no record of receiving it.

On April 2, 2009 the couple’s representative requested a conference including the following note:

Amended return filed for 2005 indicating an overpayment of refund of $28,739-plus interest please adjust your assesment [sic] accordingly.

The state responded in June of 2009 that it had not received an amended return.  Along with other correspondence the representative sent in a copy of the return in September. 

It’s too late:

By Notice of Disallowance dated October 9, 2009, the Division disallowed petitioners’ claim for refund in full, explaining that the deadline for filing the amended return had expired on April 15, 2009, and since the return had not been received by the Division until September 14, 2009, the refund must be denied.

The administrative law judge was tough on Mrs. Van Ness:

In cases of this kind, the taxpayer bears the burden of proving that the claim for refund was timely filed (Tax Law § 689[e]). It has been well established by the Tax Appeals Tribunal that where a taxpayer uses ordinary mail, the taxpayer bears the risk that a postmark may not be timely fixed by the Postal Service or that the document may not be delivered at all 

Nonetheless, the couple did get a break from the Court:

Since the request for conference, i.e., the informal claim for refund, contained references to an amended return for tax year 2005 seeking a refund in the amount of $28,739.00, by a writer who clearly believed the return had already been properly filed, the amended return and its attachments amount to writings that may be referenced in order to satisfy the elements of the informal claim. Once the amended return was provided to the Division, for what petitioners believed was the second time, any defects in the informal claim were remedied.

That extra sentence from their representative, which happened to go in on April 2, less than two weeks before the statute expired, constituted a timely informal refund claim.  Better to be lucky than good.

The Lessons

There are two lessons.  The first one I must preface by saying that I believe that you should always strive to be in compliance with the tax law.  There are, however, instances of non-compliance that are really silly.  One of these is to fail to file and pay non-resident state income tax, if you live in a high tax state.  Since you never filed the non-resident return, that state, in principle, has forever to catch you.  If they catch you after the statute has run on  your resident return, you will not be able to get the credit that you are entitled to.  If the Van Ness real estate gain had been in almost any other state than California, the New York credit would probably have been equal to the tax they paid.  Even so, it was a substantial portion of the California tax.  Their life would have been much easier if they had filed a California return in 2006 and claimed the credit on their original New York return.

The other lesson is that a refund claim for $28,000 merits a couple of bucks for certified mail even if there are still a couple of months to run on the statute of limitations.  A certified mail receipt would have saved them a court battle and got them their refund two years earlier.