State tax refund being treated as taxable income but did not lower my tax bill when itemizing

[kenuema]

I received a state tax refund from my 2022 tax return, but I received it in early 2024, not in 2023. I itemized my 2022 tax return, but my state taxes paid did not (and would not have) reduced my 2022 tax bill, so the refund should not be taxed. However, when entering the 2022 refund amount in Turbo Tax for 2024 (since that's when the refund was received, plus I received a 1099G for the 2022 refund for tax year 2024), Turbo Tax treats it as income. It does not seem to look back to my 2022 return to make the determination as to whether it is taxable. It appears to simply add it to my income.  I entered the refund in my 2023 Turbo Tax return to test it, and it appropriately is not taxed in the 2023 return. This seems incorrect & arbitrary. Am I missing something, or is this  a quirk of the software (or of the federal tax system)? Put another way, assuming Turbo Tax is correct, and it should be treated as income for 2024, if I had received the refund on 12/31/23 it would not be taxed. But if received one day later on 01/01/24, it would be taxed. Please help me figure out if Turbo Tax is wrong or if this is an arbitrary quirk that I have to live with. Thank you!

[DianeW777]

It may not be wrong, but it's unclear why you think none of it would be taxable since you did itemize your deductions in 2022. The fact that you paid state tax, unless it was a balance due paid in 2023 for your 2022 tax return, would indicate it should be taxable, or at least partially taxable. Based on your confidence that it should not be included you can simply leave it off of your tax return and keep the form in your file with notes.  

This is considered the 'Tax Benefit Rule' and you can review the information in IRS Publication 525. The basics are that if you received no tax benefit then the income is not taxable.

TurboTax has handled this accurately.

1. Open your TurboTax Online or TurboTax Desktop return > Income
2. Scroll to 'Other Common Income' > Select Refunds Received for State/Local Tax Returns > Start/Revisit/Update
3. Continue to enter your information > Enter zero for a total of all state tax payments for your 2022 tax year
4. Select 2022 as Tax Year of Refund (usually 2023) > Enter zero in the following screen since you already included it
5. Finish your tax return to see if it was included.

If you have the same experience, please update here and we will help.

From the left rail menu in TurboTax Online, select Tax Tools (You may have to scroll down on the left rail menu.)

1. Select Tax Tools
2. On the drop-down select Tools
3. On the pop-up menu titled “Tools Center”, select View Tax Summary 
4. On the left sidebar, select Preview my 1040 

For TurboTax Desktop, change to 'Forms' and review the forms 

                       

[kenuema]

Thank you for the response. The reason I think it is not taxable is because that's what Turbo Tax calculated and explained in the "Learn More" link. I erroneously entered the 2022 refund as potential income in the 2023 tax return (recall, I received it in 2024, so it shouldn't have been entered for 2023), and the software calculated $0 tax on it.  The explanation made sense to me, because I was subject to the SALT cap of $10k, so I could not use the deduction (so I got no tax benefit from it). It was not my determination that the refund was non-taxable - I learned it from Turbo Tax. Did I misunderstand the software's explanation? So, my question assumes Turbo Tax was correct and that I understand it correctly - and, if so, then I was confused why it became taxable simply because it was received in 2024 instead of 2023 as typically happens. Studying my 2024 tax return that I'm working on now, the software treats the 2022 refund simply as extra income - it does not do the calculation that I can see in the 2023 tax return where I had already entered it. Furthermore, Turbo Tax 2024 is also NOT taxing my 2023 state tax refund, just like the 2023 software did not tax the 2022 refund, mentioned above. So, it is consistent in the way it does not tax a prior year state refund, but it handles my 2022 state refund very differently in the 2024 return. 

I followed your instructions for the Income section of the 2024 software and nothing changes. The 2022 refund is still taxed while the 2023 refund is not.  I did consider excluding the 2022 refund from the software but won't that raise a red flag with the IRS since they will have received the 2022 1099G?  Thanks again for your guidance. I want to get it right, of course, but I also want to understand it and make sure it makes sense.

[DianeW777]

If you would like to send us a “diagnostic” file that has your “numbers” but not your personal information it would help.  If you would like to do this, here are the instructions:  (Don't forget to give us the state)

TurboTax Online:

Open your return -Go to the menu panel on the left side of your return and select Tax Tools. 

1. Then select Tools below Tax Tools. 
2. A window will pop up which says Tools Center.  
3. On this screen, select Share my file with Agent. 
4. You will see a message explaining what the diagnostic copy is.  Click okay through this screen and then you will get a Token number. 
5. Reply to this thread with your Token number and your state. This will allow us to open a copy of your return without seeing any personal information.  

TurboTax Desktop:

If you like, you can send a copy of your return that will be scrubbed to eliminate your personal data by using these steps:

1. Click on Online in the top left menu of TurboTax CD/Download for Windows
2. Select 'Send Tax File to Agent'
3. Write down or send an image of your token number and state then place in this issue.
4. We can then review your exact scenario for a solution.
5. Please also tell us any states included in the return. This is necessary for us to view the return.

We will then be able to see exactly what you are seeing and we can determine what exactly is going on in your return and provide you with a resolution.