Tax Season Alert: Federal Reporting Requirements for State Tax Refunds

Tax season complexity is a yearly struggle, so as 2023 approaches, it’s critical to keep up with the major developments that could affect your tax liability. 

The tax landscape is a dynamic one, with adjustments influenced by inflation and potential eleventh-hour modifications from Congress that might impact your tax return for the 2023 tax year.

For the majority of taxpayers, the interaction between state tax refunds and federal income tax is nuanced. 

Those who choose the standard deduction on their federal income tax return usually find that state tax refunds need not be included in federal income for tax purposes. This is a significant consideration, as approximately 90% of individuals claimed the standard deduction in the 2021 tax year.

However, for those who itemize deductions and receive a state tax refund, the inclusion in income becomes necessary only if the state tax paid was previously deducted. The $10,000 limit on itemized deductions for state income and property taxes is a pivotal factor, potentially exempting some itemizers from including the refund in income.

Early Preparation Crucial as Tax Deadline Nears

Nevertheless, exceptions exist, and taxpayers must be vigilant. State refunds might be taxable income if specific conditions are met, such as receiving a state or local income tax refund, credit, or offset while itemizing deductions on the federal income tax return.

Opting for state and local income taxes instead of general sales taxes can alter the taxability of a state refund, with the taxable portion limited to the amount exceeding what would have been received by choosing the standard deduction or general sales tax.

Special state payments, such as the Minnesota Walz checks and Arizona Families Tax Rebates, are also subject to scrutiny, considered taxable income despite being state-issued. As the tax deadline looms on Monday, April 15, 2024, individuals are reminded that early filing requires careful preparation. 

The IRS encourages taxpayers to check IRS.gov for quick access to refund information and answers to common tax questions. Seeking the guidance of a tax professional, particularly when dealing with the taxability of special state payments, is a prudent step before filing your federal return.