Is Your State Tax Refund Taxable? How to Figure It Out
The rules are the same but tax returns have changed
State income tax refunds can sometimes be taxable income, according to the IRS. You must report them on line 1 of Schedule 1 of the 2020 Form 1040—the return you'd file in 2021—if you claimed a deduction for state and local taxes the year before.
The IRS is basically preventing double-dipping. You can't claim a deduction for your state income taxes, then later receive a tax-free refund of that same money as well. You must effectively adjust the amount of your refund to account for the deduction you previously claimed.
When Is a State Refund Taxable?
You would have to report the state income tax refund you received last year on your federal income tax return if you itemized your deductions on your federal return last year, and if you claimed a deduction for state and local income taxes.
You couldn't possibly have itemized and claimed a state and local income tax deduction if you claimed the standard deduction on your federal return, so your refund isn't taxable if you took the standard deduction.
The State and Local Tax (SALT) Deduction
You might also be safe from claiming your state tax refund as income if you did itemize but you didn't take an itemized deduction for state and local income taxes.
This might be the case if you elected to deduct state and local sales taxes instead. You have that choice—you can deduct either income taxes or sales taxes, but not both. Your refund is only taxable if you took a deduction for state and local income taxes.
The Tax Cuts and Jobs Act (TCJA) put a cap on how much you can claim for state and local taxes. That limit is still $10,000 as of 2020.
How to Know If You Itemized
Look at your 2019 return to see if it includes a Schedule A. This is the form used to calculate your itemized deductions, so you itemized if you completed Schedule A and it's included with your return. You claimed the standard deduction if you didn't file Schedule A, so you're in the clear.
You should also be able to tell if you itemized by checking line 9 of your 2019 Form 1040. You almost certainly claimed the standard deduction if you entered $12,200, $18,350, or $24,400 in this space. These were the standard deduction amounts for the single, head of household, and married filing jointly taxpayers in that year. You almost certainly itemized if any other number appears there.
If You Deducted Sales Taxes Instead
Now you must determine if you deducted sales taxes or income taxes. Remember, state refunds aren’t taxable even if you did itemize if you opted to deduct state and local sales tax instead of state income tax.
Look at line 5a of your 2019 Schedule A. Your refund isn't taxable if the box there is checked. The IRS wants you to indicate by checking the box at line 5a if you're deducting sales taxes rather than income taxes, and there's no correlation between taking a sales tax deduction and your state tax refund.
Reporting the Income
You must figure out the taxable portion of your state refund so you can report it. You can do this using the Itemized Deductions/Schedule A Worksheet that's included in the instructions for Form 1040 provided by the IRS. You must file this worksheet along with your tax return.
Some people might have to use Worksheet 2, "Recoveries of Itemized Deductions," found in Publication 525 provided by the IRS. This worksheet is used when a taxpayer was impacted by the alternative minimum tax in the previous year and under a few other circumstances. It’s also used if you received reimbursements for any other itemized deductions you took in previous years.
State refunds are reported on line 1 of Schedule 1 of the 2020 Form 1040 after you calculate the taxable amount, then the total from line 9 of Schedule 1 is transferred to line 8 of the 2020 Form 1040.
Your tax software program might “remember” this information and even be able to calculate the correct amount of your taxable refund if you’re using the same program you used last year.
Documents You Might Need
You'll need some information to accurately complete the state refund worksheet if you must report and pay taxes on your refund. This information can be located in a few documents:
- Form 1099-G from the state or states that sent you refunds
- Your previous year’s state tax return, which shows the amount of the refund you received if you didn't receive a Form 1099-G
- Your previous year's federal Form 1040 and Schedule A, which lists your itemized deductions
Is Your State Tax Refund Taxable? Answer These 3 Questions
- Does your tax return include a Schedule A? This means you itemized, so you might have to report your state tax refund as income.
- Does line 9 of your 2019 Form 1040 say $12,200, $18,350, or $24,400? You probably claimed the standard deduction rather than itemizing, so your state tax refund most likely isn't taxable. The number that appears here will also appear on Schedule A if you itemized, so check to be sure.
- Is there a check in box 5a of your 2019 Schedule A? This means you deducted sales taxes, not state income taxes, so you don't have to report your refund as income.
IRS. "With New SALT Limit, IRS Explains Tax Treatment of State and Local Tax Refunds." Accessed Oct. 17, 2020.
IRS. "Topic No. 503 Deductible Taxes." Accessed Oct. 17, 2020.
IRS. "IRS Provides Inflation Adjustments for Tax Year 2019." Accessed Oct. 17, 2020.