Taxable Refunds, Credits, or Offsets of State and Local Income Taxes

If a taxpayer receives a refund, credit, or offset relating to either state or local income taxes, that benefit may be subjected to federal taxation the year he receives the benefit. The following situations illustrate typical events that render a refund, credit, or offset “taxable”: (1) a taxpayer receives a refund check from a state or local government after overpaying his state or local taxes, or (2) a taxpayer chose to apply part/all of a prior-year refund to his current year’s estimated state or local income tax.

Generally, taxpayers must report any such refund, credit, or offset at taxable income on Line 10 of Form 1040. The government agency that made the payment(s) to the taxpayer should have provided a Form 1099-G, with Box 2 listing the amount of the benefit. If a taxpayer never received a Form 1099-G he should contact the paying government agency, as it is ultimately the taxpayer’s duty to report the benefit.

Occasionally state and local refunds are exempt from federal taxation. For example, none of the refund is taxable if, in the year the taxpayer paid the underlying state or local income tax, he either (a) did not itemize deductions, or (b) elected to deduct state and local general sales taxes instead of state and local income taxes. For more information on potential tax-exemption of these refunds, taxpayers should consult Form 1040 Instructions’ State and Local Income Tax Refund Worksheet (see Page 23) and/or Publication 525’s Itemized Deduction Recoveries section (see Page 23). Both will guide taxpayers in determining whether their refund is taxable or not.

Photo by: DonkeyHotey