State Tax Refund Taxability

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400401402
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State Tax Refund Taxability

Post by 400401402 »

We (married filing jointly) amended 2017 tax year returns in March 2021 as it came to our attention that 401K deferrals exceeded the limit for 2017 (due to multiple employers that year).
So the 2017 amendment done in March 2021 resulted in tax due which was paid and 2017 amended return processing by IRS is complete.
This naturally also led to amendment of state tax return (again for 2017 tax year in March 2021) and taxes due to state were also paid. But turns out I overpaid the State tax due (I overestimated the interest component); so state refunded the excess promptly after state return was processed in April 2021.

Yesterday, I received two 1099-G forms from State Dept. of Revenue - Both say the are "2021 Form 1099-G" but one is for 2017 (Box 3 says "Box 2 amount is for 2017) and other is for 2020 (Box 3 says "Box 2 amount is for 2020). The latter is ofcourse for regular 2020 return return. The former is for refund issued for 2017 tax year from amended return processing in April 2021.

We took Standard Deduction in 2016, 2017, 2018 tax years.
We took itemized deductions (including state tax deduction) for tax years 2019 and 2020.

Questions to the forum:
My understanding is that no action is needed based on 1099-G received for tax year 2017 state tax refund. Is this correct ? The reasoning is that standard deduction was elected in years 2016, 2017 and 2018 anyway. In addition, this tax was only paid for amendment in 2021 and refund is related to that; so even if itemized deduction was taken in 2017, this would not have been factored into it).
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pahkcah
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Re: State Tax Refund Taxability

Post by pahkcah »

The rule is that in years you do not itemize you do not have to report the refund as income.
MarkNYC
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Re: State Tax Refund Taxability

Post by MarkNYC »

A few things regarding your 1099-G for 2017.

You said you paid the correct state tax with the 2017 amended return but included too much interest so the state refunded some of the interest. In that case the refund you received should not be a state tax refund thus not reported on a 1099-G. My guess is the state coded the payment as the correct amount of interest but too much tax paid, which generated the 1099-G.

The 2021 Form 1099-G shows a tax refund FOR tax year 2017. But in your case, the tax was actually PAID in tax year 2021. A state tax refund is taxable in the year received to the extent it was paid and deducted in a prior year and the deduction produced a tax benefit. So your standard deduction in 2017 is not really relevant since the payment was in 2021. And in your situation, the tax was both paid and refunded in 2021. When that happens, the amount refunded (aka "recovery") reduces the amount paid that can be deducted if you choose to itemize, and the refund/recovery is not taxable.

I'm not sure if the IRS can properly match a 2021 1099-G with a 2017 tax return to determine if a refund should be taxable, although in this case that would not be the proper method. You may be safe omitting the 1099-G income from your 2021 tax return, but if it was my tax return I think I would list the income and then list an offsetting negative amount with a description: "refund not taxable, tax benefit rule".
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neurosphere
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Re: State Tax Refund Taxability

Post by neurosphere »

MarkNYC wrote: Wed Jan 19, 2022 4:44 pm I'm not sure if the IRS can properly match a 2021 1099-G with a 2017 tax return to determine if a refund should be taxable, although in this case that would not be the proper method. You may be safe omitting the 1099-G income from your 2021 tax return, but if it was my tax return I think I would list the income and then list an offsetting negative amount with a description: "refund not taxable, tax benefit rule".
I like this advice, as it ensures the IRS sees the 1099-G "income" on the return to match the documents they receive. If they question the subtraction of it, you can explain in more detail later. :D
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes" (even in taxable accounts).
Hyperchicken
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Re: State Tax Refund Taxability

Post by Hyperchicken »

The general rule is that state tax refund is taxable to the extent that you have benefitted from deducting your withheld state tax, as opposed to deducting your actual state tax liability.

For example, if my itemized deductions, before adding state tax withheld, are $2,000 below the standard deduction, and I had $3,000 state tax withheld, and so I itemize, then only $1,000 of state tax refund is taxable.
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dratkinson
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Re: State Tax Refund Taxability

Post by dratkinson »

neurosphere wrote: Wed Jan 19, 2022 6:08 pm
MarkNYC wrote: Wed Jan 19, 2022 4:44 pm I'm not sure if the IRS can properly match a 2021 1099-G with a 2017 tax return to determine if a refund should be taxable, although in this case that would not be the proper method. You may be safe omitting the 1099-G income from your 2021 tax return, but if it was my tax return I think I would list the income and then list an offsetting negative amount with a description: "refund not taxable, tax benefit rule".
I like this advice, as it ensures the IRS sees the 1099-G "income" on the return to match the documents they receive. If they question the subtraction of it, you can explain in more detail later. :D


Suggestion. One and done.

Short-circuit any problems by including the explanation with your return. Would expect a one-page attachment would be all that was needed to explain your situation and the justifying tax code. Downside is you may need to file paper tax returns if tax s/w does not support electronic attachments.


Several years back I declared a personal loss due to a large uncollectible bad debt. Over several months I assembled every piece of documentation that I would have needed had I been audited, and included it as attachments. Downside was I had to file paper fed/state tax returns. The upside is nothing has yet been questioned, so I believe the effort was worth it.


Your problem should be more easily resolved so you don't need to worry about it again. One and done.
d.r.a., not dr.a. | I'm a novice investor; you are forewarned.
Topic Author
400401402
Posts: 112
Joined: Sun May 31, 2020 6:46 pm

Re: State Tax Refund Taxability

Post by 400401402 »

MarkNYC wrote: Wed Jan 19, 2022 4:44 pm A few things regarding your 1099-G for 2017.

You said you paid the correct state tax with the 2017 amended return but included too much interest so the state refunded some of the interest. In that case the refund you received should not be a state tax refund thus not reported on a 1099-G. My guess is the state coded the payment as the correct amount of interest but too much tax paid, which generated the 1099-G.

The 2021 Form 1099-G shows a tax refund FOR tax year 2017. But in your case, the tax was actually PAID in tax year 2021. A state tax refund is taxable in the year received to the extent it was paid and deducted in a prior year and the deduction produced a tax benefit. So your standard deduction in 2017 is not really relevant since the payment was in 2021. And in your situation, the tax was both paid and refunded in 2021. When that happens, the amount refunded (aka "recovery") reduces the amount paid that can be deducted if you choose to itemize, and the refund/recovery is not taxable.

I'm not sure if the IRS can properly match a 2021 1099-G with a 2017 tax return to determine if a refund should be taxable, although in this case that would not be the proper method. You may be safe omitting the 1099-G income from your 2021 tax return, but if it was my tax return I think I would list the income and then list an offsetting negative amount with a description: "refund not taxable, tax benefit rule".
Thank you. It makes sense to elaborate as much as possible to avoid delays in processing.
anita bahth
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Re: State Tax Refund Taxability

Post by anita bahth »

400401402 wrote: Wed Jan 19, 2022 11:58 am Questions to the forum:
My understanding is that no action is needed based on 1099-G received for tax year 2017 state tax refund. Is this correct ? The reasoning is that standard deduction was elected in years 2016, 2017 and 2018 anyway. In addition, this tax was only paid for amendment in 2021 and refund is related to that; so even if itemized deduction was taken in 2017, this would not have been factored into it).
The key is whether you are itemizing for 2021, which is where you would get to deduct the 2017 extra payment. If you aren't itemizing, then nothing is reported. If you are, then you must reduce the the 2017 payment amount by the 1099G refund amount (also don't forget to take out the interest payment, since that's not deductible either).

e.g You paid $1000 tax + $200 interest. You got the interest amount wrong and they returned $100 coded as a refund (that's because they see it as you having paid $1100 tax and $100 interest). You deduct $1000.

ex2. You paid $1000 tax + $200 interest. You got the tax amount wrong and they returned $100. You deduct $900.

In all 3 cases, you do not show the $100 refund as income anywhere. Include a note if you want.
dafioram
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Re: State Tax Refund Taxability

Post by dafioram »

Hyperchicken wrote: Wed Jan 19, 2022 6:55 pm The general rule is that state tax refund is taxable to the extent that you have benefitted from deducting your withheld state tax, as opposed to deducting your actual state tax liability.

For example, if my itemized deductions, before adding state tax withheld, are $2,000 below the standard deduction, and I had $3,000 state tax withheld, and so I itemize, then only $1,000 of state tax refund is taxable.
If there is no state refund then is there also no taxation of the benefit from itemizing for the state's return?

Let's say I'm expecting to have a $1000 state refund for my 2020 return paid out in 2021 and that I itemizing in 2020 and determine it's fully taxable in the 2021 return. Now if I just withholding less taxes for my state in 2020 by exactly $1000 then there is no refund and hence no taxable state income in 2021?
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