Those nice tax refunds you received after filing your state and/or local returns last year might be considered taxable income, which is why you must enter the information as you complete your federal return this year. But don’t panic; state and local tax (SALT) refunds can only be counted as income for taxpayers who itemized deductions on last year’s federal return.
If you claimed the standard deduction last year on your federal tax return, any state or local refund you received is not taxable and you don’t have to report it.
Why the different treatment? It’s because if you itemized deductions last year, you might have already claimed a deduction for the amounts you paid in state and local taxes. The IRS won’t allow you to claim a deduction for money that you didn’t actually pay in taxes; if you got a refund then you ended up with some of the money, not the state or local tax authority.
If you did itemize and did claim a SALT deduction, you’ll need to report any refunds you received. That’s because in essence, you over-reported how much tax you paid when you claimed that SALT deduction on last year’s federal return. Reporting it this year will adjust the amount of your federal refund this year to account for the excess in last what you reported last year.
EXCEPTION: If you didn’t claim a deduction for state and local income taxes then you don’t have to report the refund, even if you itemized deductions on last year’s federal return.
Taxpayers who itemize deductions on their federal income tax return can choose to deduct either state and local income taxes or state and local sales taxes. You can’t do both though. That means if you opted to claim the amount you paid in state and local sales tax when you filed your federal return last year, you’re in the clear when it comes to state and local income tax. In this case, since you haven’t already taken a deduction for these tax payments, the IRS doesn’t care about any money you received as a refund for overpaying your state and/or local tax authority.
When filing with E-file.com, our software automatically calculates the taxable amount when you enter your filing status, the amounts from Box 2 of your 1099-G and the amounts from last year’s itemized deductions. To simplify things, if you filed with us last year and your return was accepted we can pull most of this information forward for you.