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Jim202010
Level 3

Does a large state refund affect federal taxes negatively due to SALT?

I have a tendency to roll over state (and federal) tax refunds into estimated taxes as a way of absolutely preventing surprises at tax filing time.

 

I wonder if too big a state refund negatively affects federal taxes given the $10,000 SALT limitation?

 

Specifically, is the SALT amount based solely on taxes actually owed rather than involving the refund?

 

Or is it a big mistake to defer a big refund?  (Yes, I know the arguments about giving the government a free loan...)

 

1 Best answer

Accepted Solutions
Critter-3
Level 15

Does a large state refund affect federal taxes negatively due to SALT?

Normally I agree with @Hal_Al  but not this time ...

 

If your 2021 state tax return shows a refund and you choose to apply that refund to your 2022 estimated taxes, that amount is considered paid in 2021, for purposes of getting the SALT deduction, on your federal return.   If you apply your 2021 refund to the 2022 estimates it is considered paid in 2022 (since you file the 2021 return in 2022)  and is added to the 2022 Sch A as taxes paid in 2022.  This is treated the same as if you made the 2022 estimated payment on 4/15/23 with the state refund you got in your hand instead of applying it forward.  Taxes applied are always considered as paid on the first quarter even if you file your return late in the tax year which makes this a benefit for avoiding underpayment penalties.


Q. Specifically, is the SALT amount based solely on taxes actually paid (not "owed") rather than involving the refund?
A. Yes. You get to deduct the amount paid in 2021. But if you actually receive a refund, you have to treat that refund as taxable income. If you, instead, apply the refund to your 2022 taxes, you keep your deduction and do not have to pay tax on the "refund".  The 2021 refund is considered recived in 2022 even if it is applied to the 2022 estimated payments.   On the 2022 return the refund is considered taxable income even if you applied to the next tax year.  Then on the 2022 Sch A the amount of taxes you paid in 2022 is entered and will include the amount you applied from the 2021 refund.    Again this is no different than if you had recieved the refund in your hand and turned around and paid it to the state.    Having the amount applied just skips the hassle of getting the refund and making the payment.  

 

 

Q. Or is it a big mistake to defer a big refund?

A. No. For most people, that is the best stategy.   Since the SALT deduction is limited to the $10K  applying an amount in excess of that is up to you ... any state refund you get is limited to the same $10K for being taxable.  For instance if you  pay in $15K in state taxes  you would only get to deduct $10K on the Sch A   and the 1099-G showing the $15K refund only $10K would be taxable. 

 

 

One more point ... this can be confusing to some.

 

State taxes you pay during the year includes any withholdings + estimated payments + amounts applied from last tax year for that tax year.  However the estimates paid during the in January are FOR the prior tax year since the 4th payment is due the next tax year... although some pay it during the same tax year it will be applied on to avoid the confusion.   Taxes paid for the tax year are entered on that tax year's form 1040.

 

BUT on the Sch A things are different ... only taxes actually paid during the tax year are counted.   SO  the January payment for the 2021 last year's fourth quarter  + the 3 quarters in the current 2022 tax year are counted on the 2022 return.   

 

Note the differences ...  

 

Payments made IN  2022 that go on the 2022 Sch A =    1700  + any payments of prior year state taxes owed                                        

2021 Q4  Jan payment (for 2021)     $200

2022 Q1  April payment   $500  (includes any 2021 refund applied)

2022 Q2  June payment   $500

2022 Q3 Sept payment   $500

 

 

2022 estimated Payments made FOR  2022 that go on the 2022 1040 = $2300   + any payments of prior year state taxes owed 

2022 Q1  April payment        $500  (includes any 2021 refund applied)

2022 Q2  June payment        $500

2022 Q3 Sept payment          $500

2022 Q4 Jan payment (paid in 2023) $800

View solution in original post

6 Replies
Mike9241
Level 15

Does a large state refund affect federal taxes negatively due to SALT?

Maybe. Maybe not. this is due to the fact that the deduction for taxes is capped at $10,000 and also situations where you are paying alternative minimum tax. Turbotax calculates the taxable amount if any.  if some or all of it is taxable it is treated as income not an offset to itemized deductions thus increasing your adjusted gross income and many items in the tax return are affected by AGI.

if you want the calculation see the 1040 instructions page 84  but if any of the situations enumerated apply then you need to use Pub 525 page 23. the taxable portion, if any, shows up on schedule 1 line 1

https://www.irs.gov/pub/irs-pdf/i1040gi.pdf 

https://www.irs.gov/pub/irs-pdf/p525.pdf 

Hal_Al
Level 15

Does a large state refund affect federal taxes negatively due to SALT?

Deleted. 

Critter-3
Level 15

Does a large state refund affect federal taxes negatively due to SALT?

Normally I agree with @Hal_Al  but not this time ...

 

If your 2021 state tax return shows a refund and you choose to apply that refund to your 2022 estimated taxes, that amount is considered paid in 2021, for purposes of getting the SALT deduction, on your federal return.   If you apply your 2021 refund to the 2022 estimates it is considered paid in 2022 (since you file the 2021 return in 2022)  and is added to the 2022 Sch A as taxes paid in 2022.  This is treated the same as if you made the 2022 estimated payment on 4/15/23 with the state refund you got in your hand instead of applying it forward.  Taxes applied are always considered as paid on the first quarter even if you file your return late in the tax year which makes this a benefit for avoiding underpayment penalties.


Q. Specifically, is the SALT amount based solely on taxes actually paid (not "owed") rather than involving the refund?
A. Yes. You get to deduct the amount paid in 2021. But if you actually receive a refund, you have to treat that refund as taxable income. If you, instead, apply the refund to your 2022 taxes, you keep your deduction and do not have to pay tax on the "refund".  The 2021 refund is considered recived in 2022 even if it is applied to the 2022 estimated payments.   On the 2022 return the refund is considered taxable income even if you applied to the next tax year.  Then on the 2022 Sch A the amount of taxes you paid in 2022 is entered and will include the amount you applied from the 2021 refund.    Again this is no different than if you had recieved the refund in your hand and turned around and paid it to the state.    Having the amount applied just skips the hassle of getting the refund and making the payment.  

 

 

Q. Or is it a big mistake to defer a big refund?

A. No. For most people, that is the best stategy.   Since the SALT deduction is limited to the $10K  applying an amount in excess of that is up to you ... any state refund you get is limited to the same $10K for being taxable.  For instance if you  pay in $15K in state taxes  you would only get to deduct $10K on the Sch A   and the 1099-G showing the $15K refund only $10K would be taxable. 

 

 

One more point ... this can be confusing to some.

 

State taxes you pay during the year includes any withholdings + estimated payments + amounts applied from last tax year for that tax year.  However the estimates paid during the in January are FOR the prior tax year since the 4th payment is due the next tax year... although some pay it during the same tax year it will be applied on to avoid the confusion.   Taxes paid for the tax year are entered on that tax year's form 1040.

 

BUT on the Sch A things are different ... only taxes actually paid during the tax year are counted.   SO  the January payment for the 2021 last year's fourth quarter  + the 3 quarters in the current 2022 tax year are counted on the 2022 return.   

 

Note the differences ...  

 

Payments made IN  2022 that go on the 2022 Sch A =    1700  + any payments of prior year state taxes owed                                        

2021 Q4  Jan payment (for 2021)     $200

2022 Q1  April payment   $500  (includes any 2021 refund applied)

2022 Q2  June payment   $500

2022 Q3 Sept payment   $500

 

 

2022 estimated Payments made FOR  2022 that go on the 2022 1040 = $2300   + any payments of prior year state taxes owed 

2022 Q1  April payment        $500  (includes any 2021 refund applied)

2022 Q2  June payment        $500

2022 Q3 Sept payment          $500

2022 Q4 Jan payment (paid in 2023) $800

Opus 17
Level 15

Does a large state refund affect federal taxes negatively due to SALT?

I think that as long as you correctly calculate the amount of your state refund that is taxable using the tax benefit rule, it will all even out over time, although there may be year to year quirks. 

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Jim202010
Level 3

Does a large state refund affect federal taxes negatively due to SALT?

Wow, thank you.  It feels to me that this confirms the complexity of our tax system is "over the top"...  🙂 

 

fanfare
Level 15

Does a large state refund affect federal taxes negatively due to SALT?

applying your state refund to the the next year has no effect on whether your refund is taxable on federal Form 1040.

It is just bookkeeping of your estimated tax payments.

estimated tax payments don't affect your overall tax situation.

 

If you don't itemize on 1040, your state refund has  no effect at all.

 

@Jim202010 

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