The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, limited the itemized deduction for state and local taxes to $5,000 for a married person filing a separate return and $10,000 for all other tax filers. The limit applies to tax years 2018 to 2025.
As in prior years, if a taxpayer chose the standard deduction then state and local tax refunds are not subject to tax. However, if a taxpayer itemizes deductions for that year on Schedule A, Itemized Deductions, part or all of the refund may be subject to tax – but only to the extent that the taxpayer received a tax benefit from the deduction.
Taxpayers who are impacted by the SALT limit may not be required to include the entire state or local tax refund in income in the following year. As a reminder, state or local tax refunds received in 2018 that were reported on 2018 tax returns are not affected.
How much to include is figured by determining the amount the taxpayer would have deducted had the taxpayer only paid the actual state and local tax liability – that is, no refund and no balance due.
Here’s an example:
A single taxpayer itemizes on Schedule A and claims deductions totaling $15,000 on their 2018 federal tax return. Of that amount, $12,000 is for state and local taxes, $7,000 of which is for state and local income taxes. The SALT deduction is limited to $10,000, however.
In 2019, the taxpayer received a refund of $750 for state income tax paid in 2018. This means that the actual state income liability for 2018 was $6,250 ($7,000 paid minus the $750 refund). As such, the taxpayer’s SALT deduction for 2018 would still have been $10,000 even if it had been figured on the actual state and local tax paid.
Because there was no tax benefit received on their 2018 tax return from the overpayment of state income tax the taxpayer is not required to include the state income tax refund received in 2019 on their 2019 tax return.
If you have any questions about the tax treatment of state and local tax refunds, help is just a phone call away.
Any accounting, business or tax advice contained in this article, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.