When Is a State Tax Refund Considered Taxable Income?

When Is a State Tax Refund Considered Taxable Income?
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If you received a state income tax refund for last year, the money you received will count as income when you file your federal taxes this year. The Internal Revenue Service (IRS) does allow exceptions, which are based upon on how you filed your federal taxes last year.

Taxable State Refund

If you included state income taxes as part of your itemized deduction on last year's federal tax return and got a refund, it is a recovery of a tax benefit. The IRS defines a tax benefit as an itemized deduction that reduces your federal income tax. For example, if you included your state income tax as part of your itemized deductions, and received a refund of $1,000, then you report this as income this year when you file federal taxes.

Nontaxable State Refund

Your state refund is not income if you did not itemize your state income tax, but claimed the standard deduction last year. In addition, the IRS does not consider your state refund as taxable income if you elect to deduct state and local sales tax instead of state and local income tax.

Alternative Minimum Tax

You can end up not reducing your federal taxes by the full amount of your state income tax. This can occur if you were subject to the alternative minimum tax. The AMT is a second-tiered tax system that adjusts or eliminates certain tax deductions or credits. Your taxes may be higher if your income is above the AMT exemption threshold. In this case, your state income tax deduction may not provide you a full benefit and is not taxable income.

Form 1099-G

If you got a state tax refund last year, you may receive Form 1099-G from the issuing state. Form 1099-G reports certain taxable payments from the government, such as state income tax refunds and unemployment benefits. You should report the taxable portion of your state refund on Line 10 of Form 1040 even if you do not receive Form 1099-G.