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    Claiming state refunds on your tax return

    If you receive a state tax refund, the state tax authority will issue a 1099G by the end of January of next year. This form identifies the amount of refunds issued by the state, during the tax year, and is reported to the IRS. At first glance, it seems that your refund is being taxed, but in reality, it’s a necessary accounting adjustment.

    First, a reminder about tax returns. A tax return is simply a year-end tally of your actual tax liability derived from your income, deductions, exemptions, and credits. Once the tax is determined, it is compared to the accumulated withholding during the year. If your withholding is more than your tax, you get a refund. Subsequently, if you do not have enough of a withholding, you have a balance due.

    When you elect to itemize your deductions versus using the standard deduction, you include state income tax withholding that is found on your W2 and any estimated state tax payments you made during that tax year. If you receive a refund of these amounts in a subsequent year, it is a “recovery” of a previously deducted item. Since it’s more labor-intensive to amend a previous year return, the tax code requires a taxpayer to include the refund as income in the year in which it was received. The same would hold true for individuals who have city or municipality level taxes. Those tax payments and withholdings are also itemized and any subsequent refund is a recovery of what was previously deducted.

    Without this adjustment, a taxpayer could inflate their refund. For example, an individual could make a $5,000 estimated state tax payment in December. When completing his or her tax return in the following months, the individual will include this $5,000 as a part of their itemized deductions. If the withholding during the year matches their tax, the taxpayer will receive a state refund of this additional $5,000 payment. At the federal level, this additional $5,000 deduction could potentially add $1,250 to the refund. Taxpayers could do this year after year to inflate their refund if they did not have to claim the recovery as income in the subsequent year.

    If you do not itemize your deductions, you don’t have to report any state or local refunds the following year despite the fact that you received a 1099G. Since taxpayers do not always itemize each year, it is easy to overlook the requirement to report the refund when they don’t itemize.

    Joseph Smith, EA/RRT, is a director and chief financial officer of the Professional Association of Nurse Travelers (pantravelers.org). A former traveler, he can be reached at traveltax.com or josephcsmith.com.

    Because of an oversight, the byline of Kristina Osborne, Joseph Smith’s executive assistant at TravelTax LLC, didn’t appear on the February e-newsletter article entitled  “Which state tax agencies monitor professional licenses.

    Joseph Smith
    Joseph Smith, RRT, EA, is an enrolled agent and owner of TravelTax LLC (TravelTax.com), based in Norfolk, Nebraska.