Retirement tax questions

If you are reimbursed or refunded for a deduction you took in a prior year, you may need to report it on this year's tax return as taxable income.  That's because you already received the benefit of the deduction in the prior year and the reimbursement you're receiving now would be like a double benefit if it wasn't taxable.

Under the Tax Benefit Rule, you must report a reimbursement of a previously deducted expense as income, but only if you actually received a tax benefit from deducting the item. If your taxes went down as a result of a deduction, then you received a tax benefit.  The Tax Benefit Rule can be difficult to explain, and apply, so if you received a small reimbursement, you might just want to report it all as income and skip the explanation and other info below.

Not all reimbursements or refunds are taxable. A reimbursement is only taxable if you received some benefit from a deduction in a previous year. If you didn't itemize deductions in 2015, there's no benefit. 

If you received a refund of an expense you deducted in a prior year, and you used TurboTax in that year, you can use TurboTax to determine if the amount provided a tax benefit. You'll need to open a copy of your return for the prior year in TurboTax. (If you used TurboTax Online in the prior year, you may need to download a copy of your tax file and then download a copy of TurboTax for the prior year.)

Once you've opened a copy of your prior year return, you can remove the refunded expense from your itemized deductions and see if the Refund Monitor changes. If the Refund Monitor doesn't change, that generally means you received no tax benefit from that item, and as a result you don't need to report this reimbursement on your taxes.

For example, let's say you deducted $5,000 in medical expenses in 2015, then in 2016 you received a reimbursement of $1,000 of these expenses. You can open your 2015 tax return in TurboTax 2015 and change the medical expense deduction from $5,000 to $4,000 (by subtracting the $1,000 reimbursement you received from the original amount). If the Refund Monitor does not change, that generally means you received no tax benefit from the deduction of the additional $1,000. As a result, you do not need to enter $1,000 as income for 2016. If the Refund Monitor does change, then you received a tax benefit and need to enter the reimbursement amount as income.

If the reimbursement received is very large, and it changes the Refund Monitor, (and you're very patient) you might want to experiment with seeing how much of the reimbursement actually reduced your taxes. For example, you might have received a benefit from the first $400 of the reimbursed amount, but not the remaining $600. You can figure out when you stopped receiving a benefit by trying different deduction amounts between the original deduction, and the amount of deduction minus the reimbursement.

Continuing with the above example, let's say you changed the deduction from $5,000 to $4,000 and the Refund Monitor changed. You might try changing the deduction amount to $4,900. If the Refund Monitor stays the same as it was when you entered $5,000, that means you didn't receive any benefit from the final $100 that was reimbursed. You could then try $4,800, then $4,700, and so on, until you get to a level where the Refund Monitor actually changes from when it was at $5,000. (You could then go $10 at a time -- or even $1 at a time -- to find out exactly how much of the refund provided a tax benefit.) You only have to report as income the amount that caused the Refund Monitor to change from when it was at $5,000. So if the Refund Monitor didn't change until you got to $4,550, then you would only report $550 as income.

If you do need to report the refund, go to Federal Taxes>Wages & Income>Less Common Income>Miscellaneous Income>Reimbured Deductions From a Prior Year.