Question

L. A. and Paula file as married taxpayers. In August of this year, they received a $6,300 refund of state income taxes that they paid last year. How much of the refund, if any, must L. A. and Paula include in gross income under the following independent scenarios? Assume the standard deduction last year was $24,000. (Leave no answer blank. Enter zero if applicable.)

c. Last year L. A. and Paula claimed itemized deductions of $28,750. Their itemized deductions included state income taxes paid of $11,900, which were limited to $10,000 due to the cap on state and local tax deductions.

Answer 1

• The state income taxes are granted as a deduction from the taxable income. However the refund these taxes from previous year may be charged as income in the next years .
• The completion of state taxes is possible only after the federal taxes are completed .
• Thus the taxpayers generally reduce the state taxes that are withheld by their employers or the estimated payments effected by them . Thses may be higher than their actual tax liabilities.
• When the refund is received for state taxes it is considered as a recovery. And as per IRS , it is required to be added back to the income for the taxpayers' current year.

Scenarios in which the refund is taxable or non taxable :

• In case the taxpayer has taken a standard deduction in the year to which the refund pertains, the refund is not chargeable to tax in the current year as the taxes were not taken as an itemized deduction .
• Taxpayers who opted to avail itemized deductions and paid the state and local taxes in excess of the state and local tax deduction limit are not be required to consider the full amount of the  state taxes refund in income in the current year. In order to determine the amount of refund to be included in the tax return, we need to find out the lesser of the following amounts -,
  • The difference between the total itemized deductions taken in the earlier year and the amount of itemized deductions which the taxpayer would have taken in the earlier year if the  taxpayer would have paid the proper amount of state and local tax; and
  • The difference between the taxpayer's itemized deductions taken in the earlier year and the standard deduction amount for the earlier year, if the taxpayer was not eligible for taking the standard deduction in the earlier year.

In the given case, if we apply the above mentioned provisions, we can conclude that :-

• In scenario 1, where L A & Paula had filed return as married taxpayers and availed standard deduction , they do not need to include any refund in their income.
• In scenario 2, where the itemized deuduction has been availed , the amount of refund that needs to be included as taxable income will be lesser of the following -

(A) Total itemized deductions taken in the earlier year = $ 28,750

Total Itemized deductions with proper amount of taxes=  $ 26,850

( $ 28,750 - $ 11900 + $ 10000)

Difference = 28,750-26,850=1,900

OR

(B) Itemized deduction taken = $ 28,750 - Standard deduction available if opted $ 24,000= $ 4,750

Lower of A & B is 1,900