Is Your State Tax Refund Taxable? How to Figure It Out

The rules are the same but tax returns have changed

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State income tax refunds can sometimes be taxable income, according to the IRS—"sometimes" being the operative word. You must report them on line 10 of Schedule 1 of the new 2018 Form 1040, but only if you claimed a deduction for state and local taxes the year before. A lot of taxpayers will dodge having to claim their refunds as income thanks to this rule.

The IRS is basically preventing any double-dipping here. You can't claim a deduction for your state income taxes and later receive a tax-free refund 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 Income?

You might 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. It depends on whether 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 last year, and 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, and your refund is only taxable if you took a deduction for state and local income taxes.

Narrowing It Down: Did You Claim the Standard Deduction?

This question used to be easier. Forms 1040A or 1040EZ for the 2017 tax year were still in effect when you filed in 2018. You claimed the standard deduction if you used either of these returns in that tax year because they didn't give you the option of itemizing. But Forms 1040A and 1040EZ are obsolete beginning with tax year 2018.

You might have itemized if you filed Form 1040 for 2018. Look at your return to see if it includes a Schedule A. This is the form used to calculate your itemized deductions. If you completed Schedule A, you itemized. It's that simple. If you didn't, you claimed the standard deduction and you're in the clear.

You should also be able to tell if you itemized by checking line 8 of your 2018 Form 1040. You almost certainly claimed the standard deduction if you entered $12,000, $18,000, or $24,000 in this space. These were the standard deduction amounts for the single, head of household, and married filing jointly taxpayers in that tax year. You almost certainly itemized if any other number appears here.

Deducting Sales Taxes Instead

This brings us to the second rule. Did you deduct sales taxes or income taxes? 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.

If you’re using the same software program you used last year, it might “remember” this information and even be able to calculate the correct amount of your taxable refund.

Otherwise, look at line 5a of your 2018 Schedule A. Your refund isn't taxable if the box here 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 State and Local Tax Refund Worksheet 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.

After you calculate the taxable amount, state refunds are reported on line 10 of Schedule 1 of the new 2018 Form 1040, then the total from Schedule 1 is transferred to line 6 of the 1040.

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 8 of your 2018 Form 1040 say $12,000, $18,000, or $24,000?

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 2018 Schedule A?

This means you deducted sales taxes, not state income taxes, so you don't have to report your refund as income. 

Note: Tax laws change periodically, and you should always consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and is not a substitute for tax advice. Please consult with a tax professional if you're still unsure whether you must report your state refund as taxable income.