One of the more common issues that comes up in audits of New Yorkers relates to how an audit adjustment impacts their home state tax liability. And due to its proximity to New York, this is a huge issue in Connecticut, as New York spends a lot of its time auditing Connecticut residents on all sorts of personal income tax issues. Under Connecticut law, residents are entitled to a credit for taxes paid to states like New York, at least to the extent that the taxes paid on income Connecticut would deem to be sourced to New York. We've covered this issue in lots of different places over the years, including in our articles like Heads They Win, Tails You Lose: Resident Credit Problems and The Nuts and Bolts of New York’s Resident Credit, and in our blog posts like Attention Hedge Fund Investment Advisors: Connecticut Court Permits Credit for Taxes Paid on Carried Interest.
As we've discussed in some of these prior posts or articles, Connecticut had been one of the generous states that allows a taxpayer additional time to claim a resident credit for taxes paid to another state even if the statute of limitations for filing an amended return is otherwise expired. Under long standing rules, so long as the Connecticut resident taxpayer files an amended return within 90 days of the close of another state's audit, the refund claim will be timely even if the normal three-year statute of limitations has already expired.
A couple years ago, Connecticut made two changes to these technical provisions impacting tax years 2022 and forward. They didn't get a lot of fanfare back then, and why should they… these kinds of things don't rate all that much, except for nerds like us. But now that a couple of years have gone by and we’re seeing more audits of 2022 and later years, we're starting to see questions about it pop up in our practice. So now’s a good time for a quick update.
The first change is taxpayer-friendly. It used to be the case that if a taxpayer hadn't filed the tax return in another state and later got dinged for additional taxes in that state, the additional 90-day period to file an amended return didn't apply. But Connecticut has changed that rule, at least for tax periods beginning in 2022, so now the additional time applies even for taxpayers who originally didn't pay any tax to the other state.
The other change, however, isn't as friendly. While it still is true that the taxpayer is entitled to additional time to claim an additional credit for taxes paid to other states, there is essentially a “shot clock” that now applies. Specifically, the additional time to claim a refund is no longer open-ended. Under the new legislation, for tax years beginning in 2022, taxpayers only have five years from the date the original Connecticut tax return was filed to claim an additional resident credit.
In most cases, this isn't going to be a problem, since we can typically wrap up an audit in another state within that five-year period. However, it's still something to look out for. State tax audits and other states are still taking a long time, especially in New York where resources have been a bit thin in recent years. But it could be more of a problem if a taxpayer in New York, for example, is forced to litigate an issue in the New York Division of Tax Appeals. That process now takes at least a few years, so there definitely could be situations where a taxpayer who owes additional tax in New York as a result of unsuccessful litigation is going to be boxed out from claiming a refund in Connecticut due to this new five-year time limit. So this is definitely something for practitioners to keep in mind when dealing with audits of Connecticut resident taxpayers in other states.
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