Soon you will be preparing your 2013 tax return. When you do, you will need to look back and check your 2012 state tax return to see if you paid in additional state taxes or received a state refund in 2013 (for 2012).
If you paid in additional state taxes in 2013 for 2012 (or other prior years), that amount can be added to any other state taxes paid (such as state tax withholding on wages) in 2013 and deducted on Schedule A, if you itemize deductions in 2013. Note that only the tax amount is deductible, not late payment penalties or interest.
If you received a state tax refund in 2013 (for 2012), it may be fully taxable, partially taxable, or not taxable at all. Let’s start with the easy answer first: if you did not itemize deductions (but took the standard deduction) on your 2012 federal return (Form 1040), using Schedule A, then none of your 2012 state refund received in 2013 will be taxable on your 2013 federal return.
If you did itemize deductions on Schedule A in 2012 and correctly deducted all of your state tax withholding or other separate payments (such as state estimated tax payments), then some or all of your 2012 state refund (received in 2013) will be taxable on your 2013 federal tax return (Form 1040, line 10). The taxable portion of your refund is limited to the amount by which your total itemized deductions exceeded the standard deduction you could have claimed in 2012.
EXAMPLE 1; Partial taxation: On your 2012 return, you filed as a single taxpayer. You claimed itemized deductions of $6,445, of which $2,325 was for state income taxes. Your deductions exceeded by $495 the $5,950 standard deduction you could have claimed. In 2013, you received a state refund of $960 for 2012 state income tax. You must report only $495 of the refund as income on your 2013 Form 1040, line 10. The taxable recovery is limited to the $495 difference between the claimed itemized deductions of $6,445 and the $5,950 standard deduction (for a single taxpayer) for 2012.
EXAMPLE 2; Full taxation: On your 2012 return, you filed jointly with your spouse. You claimed itemized deductions of $14,900 of which $3,500 was for state income taxes. Your deductions exceeded by $3,000 the $11,900 standard deduction you could have claimed. In 2013, you received a state refund of $1,255 for 2012 state income tax. You must report the full refund of $1,255 as income on your 2013 Form 1040, line 10. The taxable recovery limit in this instance would be up to $3,000, the difference between the itemized deductions claimed of $14,900 and the standard deduction of $11,900 (married, filing jointly) for 2012.
The same rules apply to local (city or county) income taxes. State refund amounts are reported to you and the IRS on Form 1099-G. You must determine the “taxable” amount, if any.