Line 10 of your federal 1040 form is where you enter the taxable amount of state and local income tax refunds, credits and offsets that you receive during the year. The Internal Revenue Service may treat your nonfederal tax refund as a reportable recovery if you included it in your state and local income tax deduction in a prior year. When preparing your federal taxes, learning some background information about line 10 may help you avoid reporting income that you don't have to.
You can use Line 10 of your IRS Form 1040 to report the total taxable sum of state or local credits, refunds and other deductions which you have received during the year.
State and Local Income Tax Deductions
When itemizing on Schedule A, you can deduct the various state and local income taxes you paid during the year, such as estimated payments and employer withholding. Regardless of how you pay these taxes, the payment amounts are based on estimates of what your state and local tax liability will ultimately be when you file all required nonfederal returns. Despite the use of estimates, the federal government lets you take the deduction before you file state and local income tax returns even though some of the tax deducted may be refunded to you in the next year.
Tax Benefit Rule and Line 10
The reason line 10 exists on 1040 forms is because of the tax benefit rule, which requires that you report as income – in the tax year of receipt – items that you previously deducted but later recover. To illustrate how the tax benefit rule applies to line 10, suppose your 2015 W-2 reported $2,000 of state income tax withholding that you deducted on the 2015 federal return that you filed in early 2016. If you prepare the 2015 state return – also filed in early 2016 – and calculate a tax bill of only $1,500 – you overpaid by $500. Whether you request a refund, apply the overpayment to your 2016 state taxes or use it as an offset for other unpaid tax liabilities, you may need to report $500 on line 10 of your 2016 federal 1040 as the amount previously deducted that you recovered.
Tax-Free and Partially Taxable Refunds
You don't always report the entire tax refund on line 10 of your 1040. You only have to include the portion that actually saves you money in taxes in the year it was deducted. In other words, if you were to go back and reduce the amount of state and local income taxes reported on last year's Schedule A by the state refund you received this year, and the tax you recompute is the same amount of tax originally reported, your refund isn't taxable this year. To illustrate, suppose your income is relatively high and, as a result, you're subject to limitations on the total amount you can deduct on Schedule A that reduce your overall deduction. In this situation, reporting a $2,000 deduction for state and local income taxes may not save you any more in tax than a $1,500 deduction would. Therefore, if you receive a $500 refund next year, you won't have to include it as income when you file the return, because including it in your prior-year deduction didn't increase your tax savings. If instead, however, only $100 of the refund saves you money in tax – meaning the $2,000 you reported on Schedule A has the same impact as reporting a $1,600 deduction – only $100 of the refund is taxable since the remaining $400 didn't yield additional tax savings.
How Much to Report
Taking the standard deduction instead of itemizing your state and local income taxes means you won't report state refunds on line 10 of Form 1040. This money is tax free because you didn't save money in taxes with a state and local tax deduction. Under the tax benefit rule, there's no prior deduction to recover because you chose the standard deduction, which is a fixed amount that's available to most taxpayers who can't, or choose not to, itemize. In fact, your state refunds are irrelevant to your tax bill when taking the standard deduction. If you do itemize, the instructions to form 1040 have a State and Local Income Tax Refund Worksheet you can complete to determine how much, if any, of your state refund to report on line 10.
- Internal Revenue Service: Instructions for Schedule A (Form 1040)
- Internal Revenue Service: Publication 525
- Internal Revenue Service: Instructions for Form 1040
- IRS: IRS Working on a New Form 1040 for 2019 Tax Season
- IRS. "With New SALT Limit, IRS Explains Tax Treatment of State and Local Tax Refunds." Accessed Oct. 17, 2020.
- IRS. "Topic No. 503 Deductible Taxes." Accessed Oct. 17, 2020.
- IRS. "IRS Provides Inflation Adjustments for Tax Year 2019." Accessed Oct. 17, 2020.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.