It’s an odd situation, but basically the rules of tax credits are that they CAN be federally taxable IF you itemize in a particular year and deducted that year’s withholding from your income (when you itemized).
Basically this ensures money that you deducted from federal taxes is added back to your income in a later year if you get it back from the state.
what is “odd” is that you could end up being taxed for a far larger amount than you ever had withheld in the first place. Basically, this is a byproduct of the legislature wanting to use the language of tax credits instead of education savings accounts. Having spoken with a number of people involved in the original legislation, I can assure you this is an unintended consequence, and not by design.
if the IRS confirms that this is federallytaxable in the future, it will change the calculus of whether or not people who itemize should take the state income tax or state sales tax as a deduction. Happy for the experts to correct me if I am miss-stating anything here.
