California Notice Received for W-2 CA Adjustment

[sb]

My client received a notice from California stating that her imputed income from her Medical expenses is taxable. However, the medical insurance covered her son and her husband. Shouldn't this amount be tax free for California purposes? Even on her W-2, there was an adjustment for this amount and it was titled "Misc Non-Taxable Compensation." Can someone confirm what I'm saying above is true and if so, what's the CA tax code? 

[itonewbie · Accepted solution]

The adjustment is probably for HSA since CA does not conform to §223.  What is surprising is that this adjustment should have already been reflected in Box 16 of your client's W-2 as that should have been programmed into the payroll setup.

[sb]

Thank you for your quick response. Box 1 is different than Box 16 and so that's how I entered it when completing the return. Is the response to the FTB as simple as showing them the W-2 that was received?

On the notice, California stated the following:

"A review of your return indicates that your Schedule CA is incorrect.

Schedule CA is used only to report adjustments to federal adjusted gross income (AGI) when that income is taxed differently for state and federal purposes. The difference in taxation must arise from differences between state and federal tax law, not from the source of income."

[itonewbie]

The W-2 will not make a difference because the law is very straight forward, which is CA does not conform to IRC for HSA.  Did the notice not propose the changes and compute the additional tax?  If so, you should just need to check the proposed changes and agree to them if you and your client are in agreement.

If you had entered Code W as George explained, the HSA amount should flow to Schedule CA (540) Line 7, Column C to increase the state taxable income for wages.

[sb]

I don't believe it's related to an HSA. The paystubs show the following detail:

Med Imp Inc

Based on this, I believe it's an imputed income issue. Based on my knowledge, this imputed income wouldn't be taxable in California as it's related to the medical insurance to a spouse and child.

[itonewbie]

"Based on my knowledge, this imputed income wouldn't be taxable in California as it's related to the medical insurance to a spouse and child."

What is your basis for taking that position?  Rule of thumb is that all income is taxable unless specifically excluded by the tax law.  Unless you are able to cite the code and Regs for exclusion or exemption, subject to CA conformity, the presumption is that the amount is taxable.

If not HSA, it is looking like it could be either an FSA or HRA which, for CA tax purposes, is treated similarly as HSA.  Since FSA is a salary reduction plan and should be shown as such on the payslips, the term "Med Imp Inc" wouldn't fit the bill.  If Med Imp Inc shows up on the payslip only as a memo entry and doesn't make it to the W-2, I wonder then how FTB was able to pick that up as state adjustment?

I wouldn't venture to guess what the line item may be but ask the client to clarify (and probably provide a copy of the plan policy for review).  Or if it is just a trivial amount, it may not even be worth the time and the client may simply agree to settle the incremental tax.

[sb]

Thank you for the thoughtful response. I'm not sure how the FTB caught it as it shows up as the lesser amount on the state wages. I would normally have the client pay for this kind of amount, but the issue comes up every year so if the FTB made an adjustment for this year, the FTB would continue making adjustments for future years as well. I'll ask the client for the plan policy and see if I can get further clarification.

Thank you!

[itonewbie]

NP, @sb.  Let us know if we could be of help after you gather more info.

[George4Tacks]

Look at the W-2. Is box 1 the same as box 16? Is there an entry in box 12 with code W? If you made either of those entries Lacerte should have picked up the difference.

[accoun5]

Thanks-I have a similar question. An individual taxpayer was audited by IRS and the auditor didn't bother to look at the wage and income transcript. As a result, the auditor understated wage income by $114 due to an omitted W-2.  Even though the W-2 was omitted from the original return and it was on the wage and income transcript, the auditor overlooked it. The audit is over and taxpayer paid tax on audit from final determination letter. Here is the problem: Taxpayer needs to amend the CA return due to changes on federal audit. If we do the return correctly, we have to increase federal AGI by $114 over the auditor's final determination letter AGI.  Is that acceptable? Or is there a place in Lacerte to mark the $114 W-2 as non-taxable to federal in order to match the final determination letter fed AGI and show the $114 as taxable on the CA amended return?