Unfortunately, it can count as income if you itemized last year. If you itemized your tax deductions last year and included the Michigan taxes withheld as part of your itemized deductions, then the refund can be taxable. Since you paid Illinois tax against it, the tax you paid back would be counted as additional state taxes paid in.
The Tax Cuts and Jobs Act makes this a rather unfortunate exchange, however. The refund is included in income, but the extra tax may not (and probably does not) lower your taxable income because:
- The standard deduction is so much higher this year, and
- The State and Local tax Deduction (SALT) is capped at $10,000 (and includes real estate taxes as well).
In years past, the refund being claimed as income would have been subtracted right back out by paying back to the other state. But this year, because of the change in the law, it does not work out that way.
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