Is a State Refund Taxable Per the IRS?
It may come as a surprise, but the IRS considers state tax refunds to be taxable income in certain situations. Before spending your state tax refund, you may want to check with an accountant about whether you need to pay taxes on it and set money aside for next year's income tax filing.
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Why It May Be Taxable
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When you realize you must pay taxes on a state tax refund, you might view it as paying taxes on the money that you have already been taxed on. However, it is not so. A state tax refund is simply a return of the excess you have paid to the state during the previous year. You must pay federal tax on the tax refund amount because it increases your income for the current year.
Taxable Refund
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If you itemized your deductions and received a tax refund for the preceding year, include the amount on Line 10 of IRS Form 1040. The IRS instruction booklet provides a worksheet to determine whether you need to pay taxes on your state refund. By entering information, you can determine whether any part of your refund is taxable. IRS Publication 525 helps you find out whether a state tax refund is taxable.
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Form 1099-G
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If you received a state tax refund last year, you may receive a Form 1099-G from the issuing state. This is a reminder that you need to enter the amount when you file your income tax forms this year. Even you don't receive a form, you are still responsible for paying taxes if your state tax refund is taxable. If you don't receive the form, refer to the copies of your last year's income tax forms.
Tax-Free Refund
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According to the instructions on IRS Form 1040, your tax refund is not taxable if, in the previous year, you did not itemize your deductions on Schedule A and just took a standard deduction. If you chose to deduct state and local general sales taxes instead of state and local income taxes, you do not owe taxes on your state refund. If you receive a tax refund for a year other than the previous year, it may not be taxable if certain conditions apply.
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