PSA: income from U.S. obligations

[socca]

A relative recently pointed out that the portion of mutual fund dividend income from U.S. obligations is exempt from state tax. I've never paid attention to this in the past (and probably left a few bucks on the table), but with the recent rise in interest rates this now matters. It's interesting that importing my brokerage 1099-DIV into TurboTax does not automatically populate the "portion of income from U.S. obligations box" in TurboTax's version of the 1099-DIV. I have to manually calculate and enter the value myself from the detailed info provided in the 1099. I'm not aware of any technical reason why my brokerage and Intuit couldn't get together to automatically populate this field; it just doesn't happen. I'll be saving quite a bit of money on this year's state taxes by doing this additional work. This is a PSA for folks who might be in the same boat.

 

[GrayHare]

It sure would be nice if TT would let you enter the portion % number the brokerages list, and then calculate the dollar amount for you. It'd be about three lines of code to implement.

 

[jebmke]

It sure would be nice if TT would let you enter the portion % number the brokerages list, and then calculate the dollar amount for you. It'd be about three lines of code to implement.

I don't know about yours but my broker reports the percentage by fund whereas the 1099-Div is for all the funds (one number); thus, a single percentage would not be helpful.

 

[RetMD21]

I don't know about yours but my broker reports the percentage by fund whereas the 1099-Div is for all the funds (one number); thus, a single percentage would not be helpful.

Yeah the broker and TT would probably have to work together.

 

[RunningBum]

It sure would be nice if TT would let you enter the portion % number the brokerages list, and then calculate the dollar amount for you. It'd be about three lines of code to implement.

Alternately, it would be nice if the brokerages would multiply the % they give you with the amount of divs you had in that fund to give you a $ amount for that fund, and sum up the amounts for all funds. Might take 10 lines of code though.

 

[socca]

Alternately, it would be nice if the brokerages would multiply the % they give you with the amount of divs you had in that fund to give you a $ amount for that fund, and sum up the amounts for all funds. Might take 10 lines of code though.

I whipped out an Excel spreadsheet to do this. However, not all users can do this.

Intuit should at least add a warning after doing the consolidated 1099-DIV import that the "portion of dividend income from U.S. obligations" box has been set to zero, so that users interested in minimizing state taxes can do the required additional work.

Each of the flyover states that I have to file in has a different way of reducing my state tax liability. I haven't yet figured out how one state does it. I hope the additional work I'm doing on this topic is worth the money saved.

 

[Al18]

I just estimated my dividends thrown off by US obligations in my brokerage account - dividends from FBALX. This could have saved me $1.04 in state taxes. Oh well.

 

[jazz4cash]

I actually had a dispute with a CPA about this exemption. He laughed when I pointed out the mistake. He eventually admitted I was correct, but he made the same mistake the following year. Ever since then I do my own.

 

[GrayHare]

It's awfully fussy to deal with. "What's the %? What's the amount? Where's my calculator? What was that % again? OK, type in the value. Woo hoo, that reduced my tax by $1." It ranks up there with piddling, repetitive numbers on K-1 forms.

 

[jebmke]

It's awfully fussy to deal with. "What's the %? What's the amount? Where's my calculator? What was that % again? OK, type in the value. Woo hoo, that reduced my tax by $1." It ranks up there with piddling, repetitive numbers on K-1 forms.

there is no requirement to make the entries. You can elect to have the state tax your Treasury interest.

 

[joesxm3]

You should double check but I think another recent thread said that over 50% must be government to be able to deduct. A lot of funds have mainly repurchase agreements that don't count.

 

[cathy63]

You should double check but I think another recent thread said that over 50% must be government to be able to deduct. A lot of funds have mainly repurchase agreements that don't count.

Depends what state you're in. CA has that rule and I think NY does too, but most don't.

 

[socca]

Depends what state you're in. CA has that rule and I think NY does too, but most don't.

I googled this topic. As of 2016 it was CA, CT, and NY that had the rule. There is probably more recent info floating around somewhere.

 

[jldavid47]

I have a related issue. In my state, FHLB bond interest is not taxable. Schwab (and I assume any other broker) puts that interest into Box 1 rather than Box 3 of the 1099-INT. As a result, when I go to do my state return in HRBlock's software, the abount deducted for "government interest" is incorrect as they only take the interest from Box 3. I have to add the FHLB interest and override the entry which prevents me from efiling the return. Not a big deal as that saves me about $18 lol.

 

[jebmke]

I have a related issue. In my state, FHLB bond interest is not taxable. Schwab (and I assume any other broker) puts that interest into Box 1 rather than Box 3 of the 1099-INT. As a result, when I go to do my state return in HRBlock's software, the abount deducted for "government interest" is incorrect as they only take the interest from Box 3. I have to add the FHLB interest and override the entry which prevents me from efiling the return. Not a big deal as that saves me about $18 lol.

Box 3 is only for US Treasury obligations. Agency issues that may be tax exempt at the state level would not appear there if the INT is completed correctly by the broker.

These are the IRS instructions to payers

Box 3. Interest on U.S. Savings Bonds and Treasury Obligations
Enter interest on U.S. Savings Bonds, Treasury bills, Treasury
notes, and Treasury bonds

 

[Gumby]

I googled this topic. As of 2016 it was CA, CT, and NY that had the rule. There is probably more recent info floating around somewhere.

Connecticut still has that rule.

 

[Midpack]

It's awfully fussy to deal with. "What's the %? What's the amount? Where's my calculator? What was that % again? OK, type in the value. Woo hoo, that reduced my tax by $1." It ranks up there with piddling, repetitive numbers on K-1 forms.

Saved me over $800 on my state taxes, well worth the effort…

 

[socca]

I googled this topic. As of 2016 it was CA, CT, and NY that had the rule. There is probably more recent info floating around somewhere.

This non-uniform treatment among the states may explain why the brokerage can't do the calculation for the taxpayer on the consolidated 1099-DIV. The brokerage doesn't know which particular states the taxpayer is planning to file in. If, for example, the taxpayer files in NY and OH then two separate exemption calculations will be required.

For the 2023 tax year this exemption is saving me four figures in state tax vs. a total state tax liability well into six figures. Now that this exemption is on my radar screen it will be interesting to see how much state tax I save in future tax years when presumably things will return to "normal". My WAG is around $200 but we'll see.

 

[cathy63]

I have a related issue. In my state, FHLB bond interest is not taxable. Schwab (and I assume any other broker) puts that interest into Box 1 rather than Box 3 of the 1099-INT. As a result, when I go to do my state return in HRBlock's software, the abount deducted for "government interest" is incorrect as they only take the interest from Box 3. I have to add the FHLB interest and override the entry which prevents me from efiling the return. Not a big deal as that saves me about $18 lol.

I'm surprised you can't do this with HRB. Both TurboTax and TaxSlayer handle this easily.

In TaxSlayer it's done on the 1099-INT screen. There's a box where you enter the amount to subtract from your state interest income. Usually it's just the number in box 3, but if there are TVA or FFCB bonds or anything like that included in box 1, then you can just put the correct amount in the state subtraction box. There's a similar box on the 1099-DIV screen.

In TTax there's a place in the state return to enter interest and dividend adjustments. For the CA program there is a list of specific things that the state taxes differently (among them is "Interest from Ottoman Turkish Empire settlements"), and then after those items there's a place to enter "Other Adjustments" with your own description as either a positive or negative. I just enter it there.

I suggest looking for something similar to one of these options in the HRB program rather than using the override method.

 

[imbatman]

I have a related issue. In my state, FHLB bond interest is not taxable. Schwab (and I assume any other broker) puts that interest into Box 1 rather than Box 3 of the 1099-INT. As a result, when I go to do my state return in HRBlock's software, the abount deducted for "government interest" is incorrect as they only take the interest from Box 3. I have to add the FHLB interest and override the entry which prevents me from efiling the return. Not a big deal as that saves me about $18 lol.

This is available in H&R Block for my state (MD). In the MD return subtractions interview, there is a section called "Enter Income from US Obligations" and they tell you what was reported and already accounted for from the Fed Return and then have you enter the amount of Gain and Income (separately) from US Obligations, and that gets subtracted from the state return (only).

 

[mrfeh]

Saved me over $800 on my state taxes, well worth the effort…

We saved $300, so ditto.

 

[socca]

I googled this topic. As of 2016 it was CA, CT, and NY that had the rule. There is probably more recent info floating around somewhere.

Vanguard's popular Federal Money Market Fund had 49.37% U.S. government obligation income for 2023. This is rather unfriendly for residents of states that have "the rule".

 

[RunningBum]

Vanguard's popular Federal Money Market Fund had 49.37% U.S. government obligation income for 2023. This is rather unfriendly for residents of states that have "the rule".

[-]That's a selfish view. "I'm not getting a tax break on this so nobody else should" even if it's for taxes in another state.
[/-]
It's the rule that's unfriendly. You don't have to invest in that fund, but you do have to follow the rule if you live in one of those states.

I forgot that it was a 50% rule, and 49.37% is tantalizingly close. Still, it is the rule that is unfriendly.

 

[gauss]

The real question in all this is why do NY,CA,VT have the 50% restriction?

It is U.S. Federal law that impedes states ability to impose taxes on income from certain US Obligations.

Does the Federal law allow all states to place the 50% floor? Or is the Federal law silent on this and the 3 states are just taking an aggressive interpretation on this? Or maybe there was a carve out in the Federal law for those 3 states.

Absence any special treatment of these 3 states, I would suspect that the other 47 (or actually the subset that impose state income taxes) to quickly modify their laws too.

With high interest rates, and a generation of investors who are more sophisticated with fixed income investing other than the passbook savings accounts of prior generations it would seem that other states may realize that they are leaving money on the table if they can get away with this.

Perhaps a legal challenge will be forthcoming if the Federal law is truly silent on the details of this.

Don't forget that 1099-OID "phatom interest" paid yearly on zero-coupon STRIPped US Treasuries is also subtractable. I spent an hour researching this and then the tax software just did it for me LOL.

-gauss

p.s. I didn't necessarily read socca's above comment as selfish.
p.p.s I think I saved about $100 this year, but looking forward to $1,000 next year of savings.
p.p.p.s Don't forget balanced funds / target funds etc often contain US Obligations too.

 

[socca]

... Absence any special treatment of these 3 states, I would suspect that the other 47 (or actually the subset that impose state income taxes) to quickly modify their laws too. ...

Having spent more time on this topic recently than it probably deserves my preference would be for "the rule" states to join the other 47 states and abandon it. This could simplify 1099 reporting and tax return prep.

The point of my recent post was that if Fidelity (for example) offered a competing fund with 50.03% income from U.S. obligations, this would be more friendly to residents of "the rule" states.