You recently wrote that people who took a 2012 itemized deduction for state taxes must report 2013 state refunds as income. I claimed a big superstorm Sandy loss on my 2012 tax return. As a result, I received a larger-than-usual state refund. Must I report that refund as 2013 income, even though it was caused by Sandy?
Unfortunately, the answer has nothing to do with the underlying reason for the refund.
From what you say, your Sandy losses reduced your 2012 state tax liability. As a result, you had already paid more state tax than you owed -- say, via payroll withholding. So you got a state refund in 2013. Whether you must report it as income on your 2013 federal return depends on two things:
1) Did you take an itemized deduction on your 2012 federal tax return for state income taxes you paid in 2012?
2) Did that deduction result in a tax benefit for you -- i.e., did it reduce your federal tax bill?
If the answer to both questions is yes, you must report the refund as 2013 income, says Alan E. Weiner, a Melville CPA. But if you took a 2012 deduction for state taxes and it didn't reduce your federal tax bill, you don't have to report your state refund as 2013 income. Taking an itemized deduction for state taxes doesn't always result in a tax benefit, he adds. For example, if you're subject to Alternative Minimum Tax -- as many Long Islanders are -- taking that deduction doesn't change your federal tax. You get no benefit from it. Therefore, any state refund you receive isn't taxable.
The bottom line If you reduced your 2012 tax bill by claiming a deduction for state taxes, you must report a 2013 state refund as income on your 2013 return.
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