Received a 1099-G. How do I calculate the recovery amount to include in income?

[novice23]

I received a 1099-G for a prior year state income tax refund. When inputting the 1099-G information into the tax software, it said it was a special case, and directed me to IRS Publication 525 to figure the amount I need to enter into the software, which will go into Schedule 1, Line 1 of the 1040.

In the prior year, I was subject to the AMT. 

IRS Pub. 525 states: "If you were subject to the AMT in the year of the deduction, you'll have to refigure your tax for the earlier year to determine if the recovery must be included in your income. This will require a refiguring of your regular tax, as shown in Example 35, and a refiguring of your AMT. If inclusion of the recovery doesn't change your total tax, you don't include the recovery in your income. However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year." 

I do not understand what the IRS is saying in the highlighted part of the above statement. In layman's terms, exactly what portion of my recovery do I include as part of income in the tax software? I have manually refigured my total tax for the prior year and have determined that my total tax did increase as a result of including the recovery/refund.

Thanks!

[KrisD15]

It would be the difference between what your tax would have been had you taken the Standard Deduction, and the increase that you just calculated. 

So, say the refund was 1,000.  If the deduction resulted in saving 500 tax, but if you took the standard deduction, your tax would have gone up by only 400, you would only claim 400 of the refund. 

If the deduction was 2,000, but your state tax was limited by the SALT limit, in the amount of 2,000 or more, the limit would offset the refund and you would not need to report any of the refund. 

[novice23]

Thanks so much for the quick response! So if I understand correctly, I would calculate as follows:

- Let's say I received a state refund amount of $18,000 for tax year 2022.

- In 2022, I itemized deductions, with a Schedule A, line 5a of $17,000, Schedule A, line 5d of $20,000, and Schedule A, line 17 of $17,000.

- I refigured my tax for 2022 by including the $18,000 refund amount, which reduced 2022 Schedule A, line 5a to -$1,000 and Schedule A, line 17 to below the standard deduction amount. 

- Since the refiguring of Schedule A resulted in a lower itemized deduction amount than the standard deduction, I used the 2022 standard deduction ($12,950) to refigure my total tax.

- This resulted in an increase of the total tax (1040 line 24) of $2,000.

So would I include in my 2023 income the difference between the original total tax and the refigured total tax ($2,000) (1040 line 24), or the difference between the original itemized deduction and the refigured standard deduction ($4,050), or something else?

[DianeW777]

It depends.  The state and local taxes that are limited on Schedule A to $10,000.The worksheet in the link provided will allow you to be certain exactly what to include in your 2023 tax return because of the limitation. 

• Form 1040 Instructions (page 86)

@novice23