A different State Tax Refund Recovery Exclusion Error

[RetiredinMich]

I have a 1099-G from the state for approximately 1/3 of my January 2021 estimated tax payment. I am a cash basis taxpayer so none of these amounts were reflected in my 2020 itemized deductions. When I enter the 1099-G, TT says "lets see if any of this amount is taxable. I have reentered the data 3 times so I am confident I am answering all the questions correctly. TT determines that almost 1/2 of the refund is taxable. The fact pattern is different, but TT seems to be making the same logic error sweetwine_man reported last April 2021. 

IRS Pub. 525 (pg.23) offers clear guidance in both these cases: "Recoveries ... Tax benefit rule. You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered amount reduced your tax in the earlier year."

Since the recovery had no effect on the prior year's tax, I assume I can obtain the correct tax result by deleting the 1099-G. That may trigger an audit flag and it sure won't fix the issue for other users.

Anyone have thoughts on this situation?

[AliciaP1]

If you itemized your deductions in 2020 and you populated line 5a with your "state and local income taxes" with your income taxes withheld or paid by estimated payments during 2020 then the amount received on the 1099-G is taxable in 2021.

State income tax withholding is a periodic "payment" of estimated taxes just like the actual estimated payments.  When you deduct these payments via itemized deductions, they are removed from taxable income.  If you receive a refund of any part of this deduction, you then owe tax on the amount. 

[RetiredinMich]

The key point is - Line 5a was populated with the amount of withholding and estimated taxes actually PAID in 2020. The January 2021 Estimated Tax Payments were not paid in 2020, so WERE NEVER DEDUCTED, hence the refund of a portion of payments never deducted should not be included in income. Again quoting from Publication 525: "If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and isn't reported as income."  While the answers to the Turbo Tax questions seem to clearly spell out this situation; the software seems to use the logic that half the total tax was paid in 2020 and half the tax was paid in 2021, therefore half the refund should be allocated to the payments deducted in 2020 and be included in 2021 income as a recovery of the deductions THAT WERE NEVER TAKEN. 

I tried to follow the IRS instructions for Schedule A, which pointed to Schedule 1 instructions, which then pointed to Publication 525 if an exception applied. In this case Exception 5 in the Schedule 1 instructions applies: "You made your last payment of 2020 estimated state or local income tax in 2021." As a cash basis taxpayer, the recovery and the expense occurred in the same year (2021) and per Publication 525 should not be reported as income. The IRS instructions seem straight forward and logical to me and clearly at variance with the Turbo Tax calculations.