Claiming State Refunds As Income

Remember those little cards you receive from the State each year showing how much of a refund you received for the prior year?

Does it make your blood boil to think that you have to include that amount into your earnings when you file?

Well, don't get to riled over it, there is a perfectly good justifiable explanation. Let me explain.
The only taxpayers who have to claim their State refunds as income are those who itemize deductions on Schedule A, i.e. mortgage interest, real estate taxes, medical and W-2 withholding of State taxes paid, etc.

Yes, that's right. If you itemize, you get to add to those deductions the amount that you had withheld on your W-2 for State tax withholding (Line 5, Schedule A - State and Local Income Taxes).

So it's more or less a trade-off, a deduction for what you paid into the State for claiming what you received for that benefit. Generally what you have to claim as income (refund) is much less than the benefit of claiming the State taxes withheld, unless, you don't have enough withheld on your W-2 for State withholding, then you're not going to get much of a deduction on your Schedule A.

Now on the other hand, those taxpayers who do not itemize and take the Standard Deduction do not have to claim the State refund on their returns. Why? Because they did not itemize and claim the State tax deduction.

Overall, just think of it as a "give and take" situation, the IRS gives you the deduction and you take the refund as income, pure and simple.