My wife and I were audited by NC this year for 2019, 20, & 21. I was informed by OPM that my wife qualified for the Bailey Settlement which excludes her from paying state taxes on her annuities. She doesn’t qualify and we got slapped with a hefty bill of 3 years of back taxes, penalties, and interest. We took out a second mortgage and paid the state and I applied for consideration to receive the penalties and interest be refunded. The state has refunded us for the penalties and some of the interest charges. My question is does this refund of my debt in penalties and interest count as income on my federal or state taxes? I don’t think it should because I haven’t really gained anything but received basically a reduction in funds owed. I know this is a tough question and I am grateful for the person who can help me!
