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Why is my 1000 dollar MA state tax credit (solar energy system) subject to federal tax?

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Why is my 1000 dollar MA state tax credit (solar energy system) subject to federal tax?

It depends.  If you received a refund on your Massachusetts state tax return last year and itemized your deductions on your Federal return, any refund of the income tax (which includes this solar energy credit) could become partially or fully taxable on your Federal return this year.

Here's the reasoning:  Since you took a deduction for the entire amount of Massachusetts tax that was withheld and/or paid for tax year 2016, your Federal taxable amount was also reduced by these state taxes.  Had you known how much of a state refund you were going to receive, you would have had to subtract your refund from your state tax deduction, reducing your Federal refund some.  However, you did not (and could not) have known this amount, so the IRS allows you the full amount.  But now they require you "pay" that amount back by reporting the refund on your tax return.

Having said this, there are circumstances in which not all of the state refund is taxable.  If you filed with TurboTax last year,  TurboTax will have saved these numbers to calculate the correct amount of the refund that is taxable.  If you didn't file last year and have access to a copy of your tax return, TurboTax will ask you questions from your return to see how much of it is taxable.

However, if you took the standard deduction on your Federal return last year, your state refund (which includes this credit) is not taxable on your Federal return, and even if you enter this information into TurboTax, the amount is filtered out when you answer yes to the question if you took the standard deduction last year.

This FAQ will provide additional information:

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