Tax Help

Need tax help and understanding if your state tax refund is taxable?

Taxpayers often ask their preparer “why in the world in this state tax refund taxable, it is just a return of my money.” The answer is found in the concept of the tax benefit rule which requires a taxpayer to include the refund in income to the extent that this deduction reduced tax liability in the previous year. The easy way to think about this is as follows:

You have $ 5,000 state income tax withheld from your paycheck and reported on your 2013 IRS Form W-2 which you then deduct as an itemized deduction on Schedule A. Once your 2013 state income tax return is completed you discover your tax was $ 4,000, resulting in a $ 1,000 refund. The $ 1,000 is your tax benefit which reduced your federal income tax by this amount times your tax bracket and is able to be included as income in 2014, assuming you actually received the refund or if it was credited to any other tax period.

I use state tax refund as the example because it is the typical item associated with the tax benefit rule. As with all tax laws there are many exceptions to the requirement to include the refund as taxable. Situations where a tax refund will not be taxable:

• The standard deduction was claimed
• Sales tax was deducted in lieu of state income tax

There are also situations when a state tax refund may be partially taxable which are far too numerous to address here.

Make sure you provide your tax preparer the IRS Form 1099-G which you will receive notifying you of a refund issued by your state and to also provide them with a copy of your previously filed return which will help them determine if any amount is taxable.


Call today to find out how Community Tax can assist you with tax help: (800) 444-0622