Wednesday, January 28, 2015

Are State Refunds Taxable?


Each year, when you file your federal tax return, you have the option to deduct your state taxes to reduce your adjusted gross income.

This option is available if you decide to itemize your deductions on Schedule A.  On this form, you have the option to either deduct state sales taxes or state income taxes, but not both.

Here are three cases to consider:

Exact Payment
$500 was withheld for state income taxes
You owed $500 in state income taxes

In this case, when you do your federal income taxes, assuming you take the "state income taxes itemized deduction", you will deduct $500.  If you are in the 25% tax bracket, this will save you $125.

Over Payment
$700 was withheld for state income taxes
You owed $500 in state income taxes

In this case, when you do your federal income taxes, assuming you take the "state income taxes itemized deduction", you will deduct $700.  If you are in the 25% tax bracket, this will save you $175.

Next year, you will report your $200 state refund as income.  If you are in the 25% tax bracket, this will cost you $50.

In the end, this will save you $125 total.

Under Payment
$400 was withheld for state income taxes
You owed $500 in state income taxes

In this case, when you do your federal income taxes, assuming you take the "state income taxes itemized deduction", you will deduct $400.  If you are in the 25% tax bracket, this will save you $100.

Next year, if you add the $100 paid in state income taxes to the "state income taxes itemized deduction", you will save an additional $25.

In the end, this will save you $125 total.


See brrinc.org and blog.turbotax.intuit.com for more details.

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