Why is non-taxable state refund being subtracted on this year's schedule A?

[Jsteven408]

A non-Taxable State Refund is showing up as a deduction on schedule A.

Taxes were itemized in 2024 and SALT cap limited. The excess over the cap is more than the refund. In this case there was a state payment with the state extension in 2025. TurboTax correctly determined that the refund was not taxable ("above the AGI line)".

The IRS Instructions for Schedule A line 5a state (emphasis added):

"Don't reduce your deduction by any:

• State or local income tax refund or credit you expect to receive for 2025; or

• Refund of or credit for prior year state and local income taxes you actually received in 2025. Instead, see the instructions forSchedule 1 (Form 1040), line 1."

The TT treatment would make the refund taxable "below the AGI line" if one was below the new SALT cap and itemizing in 2025.

Another Tax Software program does not make the schedule A deduction.

1) Which is correct?

2) If TT is in error, how to fix?

[Jsteven408]

Furthermore, TurboTax is inconsistant.  If the state surplus payment is listed as being applied to furture state taxes rather than a cash refund, it is properly treated as a 2025 additional state payment with no corresponding subtraction just because you made 2024 state payments in 2025.

One source said "This is a software limitation, not the law.... The 2024 refund should NOT reduce your 2025 Schedule A."

TurboTax accuracy guareentee is very limited.  In only covers tax penalties for paying too little, It doe NOT cover overly conservative (inacurrate) calculations that cost the taxpayer money, but does not result in penalties.

[DianeW777]

Since you were limited due to the state and local tax (SALT)  limitations on your itemized deductions last year your refund may not be taxable at all. 

A refund of state tax for 2024 received in 2025, would not reduce the total SALT paid in 2025. If the amount refunded was tax from the same tax year (2025), in this case you would reduce the current year total tax with the balance entered on your itemized deductions (Schedule A). This is not common.

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 Desktop for Windows
2. Select 'Send Tax File to Agent'* > Follow the prompts to reach the token number.
   • Enter your email used for TurboTax > Enter your code > Send
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.
   • *If using a MAC, go to the menu at the top of the screen, select Help, then, 'Send Tax File to Agent')

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

[Jsteven408]

The file requested is attached and the state is CA.

The problem is the TT worksheet for state refunds (line 19) states for itemized deductions in 2025 to NET the non-taxable state refund received in 2025 for TY 2024 with the state 2024 extension payment made in 2025 for TY2024. This is directly contrary to the  IRS instructions in Schedule A line 5a that says do not reduce your 2025 schedule A itemized state taxes and to (only) evaluate the state refund for taxability. I have confirmed that the IRS statement is correct with an enrolled agent and with AARP Tax-Aide that TT is incorrect iand way overconservative n their interpretation in TT explicit implementation in the TT state refund worksheet.

TT correctly identifies my refund as non-taxable but incorrectly subtracts it from 2025 paid state taxes with includes a 2024 extension payment.  While this may sound logical, per my late spouse (a CPA) drilled into me "the tax code is rule based, not logic based.

[DianeW777]

Upon review of your diagnostic file, it's important to note that if you paid tax and received a refund of that tax in the same tax year (2025), even if it was for the 2024 tax year, the adjustment must be made.  Your extension payment, would be offset by any refund you received in that same tax year (paid and refunded in 2025).

• If you receive a refund of (or credit for) state or local income taxes in a year after the year in which you paid them, then all normal rules apply as you indicate. 

However, you must reduce any state taxes paid and refunded in the same tax year before entering the total state and local taxes paid on Schedule A. 

TurboTax is correctly reflecting this.  This is not new tax law, it's simply not as common.

@Jsteven408 

[Jsteven408]

Thanks, DianneW777.

Apparently Schedule A, line 5a instructions are simplistic and over-riden by Pub 525.

The latest Pub 525 (2024) example 28 covers this case:

Example 28. You paid 2023 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2024. You had no state income tax withheld during 2023. In 2024, you received a $400 tax refund based on your 2023 state income tax return. You claimed itemized deductions each year on Schedule A (Form 1040). You must allocate the $400 refund between 2023 and 2024, the years in which you paid the tax on which the refund is based. You paid 75% ($3,000 ÷ $4,000) of the estimated tax in 2023, so 75% of the $400 refund, or $300, is for amounts you paid in 2023 and is a recovery item. If all of the $300 is a taxable recovery item, you'll include $300 on Schedule 1 (Form 1040), line 1, for 2024, and attach a copy of your calculation showing why that amount is less than the amount shown on the Form 1099-G you received from the state. The balance ($100) of the $400 refund is for your January 2024 estimated tax payment. When you figure your deduction for state and local income taxes paid during 2024, you'll reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes paid during 2024 will include the January net amount of $900 ($1,000 − $100), plus any estimated state income taxes paid in 2024 for 2024, and any state income tax withheld during 2024.

TT is correct and Schedule A instructions are incomplete at best.