State Tax Refunds - Taxable or Not

[GMoney14]

Hi there,

I've got actually a couple of questions pertaining to whether my 2018 state income tax refund is taxable or not.  I received in 2019 a state income tax refund for the 2018 tax year, I itemized my 2018 return, and did not elect the state and local sales tax deduction for line 5a.

When looking at the supporting workpaper (2019 State and Local Income Tax Refund Worksheet) but particularly Part IV, Line 13, what is this line for?  Is this line to report any state tax refunds received in 2019 that were for the 2017 tax year and prior?  If it is not, what is this for then?

Also, what schedule is TurboTax referring to when Part IV, Line 13 has the following..."Total line 36 column (d)"?

According to the TurboTax Software as well as working the State & Local Income Tax Refund Worksheet in the 2019 Sch A instructions, it appears that my refund is not taxable.  However, when i read other literature on this matter on various other tax websites, it seems that the refund is taxable.  I know what is written out there is for the masses but  I'm just trying to get some comfort on this particular issue.  Any guidance / help is appreciated.  Thanks.

[VolvoGirl]

A State Tax Refund is taxable if you itemized deductions on that prior year's federal return and took a deduction for state income taxes instead of the sale tax.  You got a deduction benefit for it so now you have to include it as income. If you took the standard deduction it is not taxable and you don't need to report it.

Is the little checkbox to the left of 5a checked?  If it is checked you took the Sales Tax Deduction instead of State Income Tax so it would not be taxable.  If it is not checked you took income tax as a deduction so the refund would be taxed.

You said you did not take anything on line 5a?  No amount at all?  Seems like if you Itemize you would have one or the other.  Income tax OR sales tax.

[Opus 17 · Accepted solution]

If you have the desktop program and are entering information directly on the worksheets, that voids the accuracy guarantee. It’s very strongly recommend that you use the interview mode unless you know exactly what you’re doing.

Without reference to the specific worksheets, which I have not reviewed, for any refund you have to apply the “tax benefit rule”.   A state tax refund is taxable income if you received a tax benefit by deducting your state income taxes on a previous tax return.  The most common situation would be that you deducted your state and local income taxes on your 2018 return, and then received a state tax refund during the calendar year 2019. This becomes taxable income on your federal 2019 tax return if you received a tax benefit.

for example, suppose that you took the itemized deduction in 2018 and the total of your itemized deductions was $11,000, including $4000 of state and local income taxes from your W-2, and then you received a $1500 state income tax refund.  This would mean that your correct state taxes for the year were $2500.  If you had only deducted the $2500 state income taxes, your itemized deductions would have been less than the standard deduction and you would have taken the standard deduction of $10,000. That means that your tax benefit was $1000, so $1000 of your refund is taxable even though the refund was larger.  Normally, TurboTax will perform the tax benefit calculation for you if you answer the questions correctly.

The tax benefit rule applies to any state income tax refund. If you received a refund in 2019 for an earlier tax year, such as 2016 or 2017, you would perform the same analysis with regard to any tax benefit you might’ve gotten on your 2016 or 2017 return, and the refund would or would not be taxable based on that analysis.  

(The tax benefit rule in fact applies to any refund of a previous deduction, including refunds of mortgage interest or property taxes or business expenses. Anytime you are refunded money that you originally got a tax benefit from a deduction, the refund is a taxable recovery. You are on your own to calculate most taxable recoveries, TurboTax only automatically asks about state income tax refunds.)

[GMoney14]

Hi Opus,  

Thanks for the response and information.  It was most helpful.

Let me ask you this question.  We live in a state with high property taxes and so with the real property and personal property taxes paid in the 2018 tax year we nearly reach the $10,000 limit.  I believe it was around $9800 in property taxes paid during the 2018 tax year.

So with that said, we would have only utilized around $200 in state income taxes paid as a deduction on our return for the 2018 tax year.  

Does that make a difference any?  Would that reduce the taxable amount of our 2018 state income tax refund?

Let me know your thoughts as well as if you have any questions. 

Thanks again for your help.  It's greatly appreciated. 

[Opus 17]

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@GMoney14 wrote:

Hi Opus,  

Thanks for the response and information.  It was most helpful.

Let me ask you this question.  We live in a state with high property taxes and so with the real property and personal property taxes paid in the 2018 tax year we nearly reach the $10,000 limit.  I believe it was around $9800 in property taxes paid during the 2018 tax year.

So with that said, we would have only utilized around $200 in state income taxes paid as a deduction on our return for the 2018 tax year.  

Does that make a difference any?  Would that reduce the taxable amount of our 2018 state income tax refund?

Let me know your thoughts as well as if you have any questions. 

Thanks again for your help.  It's greatly appreciated. 

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Yes, that's the tax benefit rule I was talking about. 

Let's suppose your other state and local taxes were $9800 as you say.  Your state income tax withholding on your W-2s was $5,000, but you could only claim a $200 deduction because of the SALT cap.  You got a $1000 state tax refund.  That means your final state income tax was $4000.  Since that was still more than the $200 SALT cap, your federal deduction would have been the same with or without the refund.  You got no tax benefit from that extra $1000 in state income tax since it wasn't a deduction, so the refund is not taxable at all. 

(Turbotax should do this calculation for you if you use it year over year.)

[datalin]

Hi I have a similar situation.   my total state and local taxes paid in 2020 was 13500, including 7000 in state withholdings, 6000 in property taxes, and some other little stuff.    I received a 4000 state tax refund in 2021 (for 2020).  Ive been using turbo tax for years, and as it says above, turbo tax should have seen the entire amount of state and local taxes and calculated that only $500 of the refund was taxable, (becauese $3500 was disallowed) but it didn't.    I don't understand why it didn't do it, and I'm hesitating to input it manually, but I really want to not have to claim the income!   can you give some advise?

[Opus 17]

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@datalin wrote:

Hi I have a similar situation.   my total state and local taxes paid in 2020 was 13500, including 7000 in state withholdings, 6000 in property taxes, and some other little stuff.    I received a 4000 state tax refund in 2021 (for 2020).  Ive been using turbo tax for years, and as it says above, turbo tax should have seen the entire amount of state and local taxes and calculated that only $500 of the refund was taxable, (becauese $3500 was disallowed) but it didn't.    I don't understand why it didn't do it, and I'm hesitating to input it manually, but I really want to not have to claim the income!   can you give some advise?

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We on the board can't see the calculations, and you can't see the worksheet where the calculations are unless you are using the version installed on your own computer.  Your calculation sounds correct, so it should be safe to enter $500 and then answer "just assume it is all taxable" rather than asking the program to go through the calculations.  If you wanted to really investigate the problem (instead of just filing), you can contact customer support and see if they will do a screen share with the product quality team (it would have to be escalated from the first level of support).