Even when your refund is taxable, it may not be the entire amount. It depends on how much the deduction affected your refund or tax bill. So, those questions are determining how much, if any, tax benefits you received for claiming the state income tax deduction (instead of the sales tax or standard deduction).
A general rule of thumb: If you didn’t deduct state and local income taxes last year, you don’t need to pay taxes on your state and local tax refund this year. For instance, if you didn’t itemize your deductions last year and instead you took the standard deduction, then your state tax refund from the previous year is tax-free this year.
Sales Tax Deducted, But Not State Income Tax?
There’s an important note to consider in regards to sales tax versus state and local income tax. On last year’s return, if you itemized your deductions and were able to deduct your sales tax and not your state and local income taxes, then your previous year’s state refund is not taxable when you file this year.
If you deducted your state and local income taxes last year and also received a state refund last year, then your state tax refund that you received from the previous year may be taxable.
Whether or not your state income tax refund is taxable on your federal income tax return depends on whether you took an itemized deduction (Schedule A (Form 1040)) for the tax that was later refunded. TurboTax is using your answers to those withholding questions to figure this amount......
- Don't report any of the refund as income if you didn’t itemize your deductions on your federal tax return for the tax year that generated the refund.
- If you took an itemized deduction in an earlier year for taxes paid that were later refunded, you may have to include all or part of the refund as income on your tax return. Use Worksheet 2, Recoveries of Itemized Deductions in Publication 525, Taxable and Nontaxable Income to determine the taxable amount of your state or local refunds to report on your tax return.
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