Are tax federal or state tax refunds taxable in the next tax year?

Question

If I get a refund from IRS and or from a state tax agency, will that refund be considered taxable income for the next year's federal or state income taxes?

Answer 1

IRS refunds are not taxable.

State/local refunds are taxable, if you itemized your deductions for that year, to the extent that the overpayment provided tax benefit. IRS provide a worksheet to calculate that.

Just to clarify: this is taxable in the year received. You do not need to amend the prior years. So if you received a $100 refund for State taxes you paid in 2010 in the year 2012 - it will appear on your 1040 for the year 2012, no need to amend 2010.

Answer 2

The state income tax refund is taxable if you deducted your state income tax withholdings the previous year.

If you itemize your deductions using Schedule A, one of the expenses you can deduct is state income taxes. However, the amount you deduct here is not what your tax burden ended up being on your state tax return, but the amount of state tax that you paid during the year. This includes the amounts withheld from your paycheck(s) during the year, any estimated state income tax payments you sent in, and any payments of state income tax for previous years that you sent in with your state tax return for the previous year. If you receive a state refund after you do your state tax return, it means that you essentially deducted too much, and the refund is taxable. Because you pay your tax (withholding) in one tax year, and you get your refund in the next tax year, these two actions happen on separate federal tax returns.

Example:

• During 2015, $3000 was withheld from your paycheck for state income taxes.
• On your 2015 federal tax return, you itemized your deductions, and you deducted $3000 from your income on Schedule A Line 5.
• When you did your 2015 state tax return, you found that your state income tax burden was only $2000, so you received a state tax refund of $1000 (which was received in 2016).
• On your 2016 federal tax return, you need to add your $1000 state tax refund (found on the 1099-G you received) to your income on line 10.

If you did not itemize deductions the previous year, and instead took the standard deduction, or if you itemized but did not take the state income tax deduction (taking the sales tax deduction instead), you do not need to add the 1099-G refund to your income (see the instructions for 1040 Line 10).

The federal tax refund is never taxable on your federal tax return or on your state tax return.