The IRS is basically preventing double-dipping. You can’t claim a deduction for your state income taxes, then later receive a tax-free refund of that same money as well. You must effectively adjust the amount of your refund to account for the deduction you previously claimed.
When Is a State Refund Taxable?
You would have to report the state income tax refund you received last year on your federal income tax return if you itemized your deductions on your federal return last year, and if you claimed a deduction for state and local income taxes.
The State and Local Tax (SALT) Deduction
You might also be safe from claiming your state tax refund as income if you did itemize, but you didn’t take an itemized deduction for state and local income taxes. This might be the case if you elected to deduct state and local sales taxes instead. You have that choice—you can deduct either income taxes or sales taxes, but not both. Your refund is only taxable if you took a deduction for state and local income taxes.
How To Know If You Itemized
Look at your previous year’s tax return to see if it includes a Schedule A. This is the form used to calculate your itemized deductions, so you itemized if you completed Schedule A and it’s included with your return. You claimed the standard deduction if you didn’t file Schedule A, so you’re in the clear. You should also be able to tell if you itemized by checking the actual 1040 form used last year. You almost certainly claimed the standard deduction if you entered the standard deduction amount on one of the lines in the form. If there are other numbers that don’t match one of the standard deduction amounts for that year, you almost certainly itemized.
If You Deducted Sales Taxes Instead
Now you must determine if you deducted sales taxes or income taxes. Remember, state refunds aren’t taxable if you itemized and if you opted to deduct state and local sales tax instead of state income tax. Look at line 5a of your previous year’s Schedule A. Your refund isn’t taxable if the box there is checked. The IRS wants you to indicate by checking the box at line 5a if you’re deducting sales taxes rather than income taxes, and there’s no correlation between taking a sales tax deduction and your state tax refund.
Reporting the Income
You must figure out the taxable portion of your state refund so you can report it. You can do this using the Itemized Deductions/Schedule A Worksheet that’s included in the instructions for Form 1040 provided by the IRS. You must file this worksheet along with your tax return. Some people might have to use Worksheet 2, “Recoveries of Itemized Deductions,” found in Publication 525 provided by the IRS. This worksheet is used when a taxpayer was impacted by the alternative minimum tax in the previous year and under a few other circumstances. It’s also used if you received reimbursements for any other itemized deductions you took in previous years. State refunds are reported on line 1 of Schedule 1 after you calculate the taxable amount. Then, you’ll take the total from line 10 of Schedule 1 and transfer it to line 8 of Form 1040.
What Documents Do You Need?
You’ll need some information to accurately complete the state refund worksheet if you must report and pay taxes on your refund. This information can be located in a few documents:
Form 1099-G from the state or states that sent you refundsYour previous year’s state tax return, which shows the amount of the refund you received if you didn’t receive a Form 1099-GYour previous year’s federal Form 1040 and Schedule A, which lists your itemized deductions
