Refunds of Previously Deducted Items

If you recover or receive back an amount that you had already deducted on a prior year's return, you generally must report the recovered amount as income in the year you receive it. This rule saves you the trouble of having to file an amended tax return for the prior year.

State or local income tax refunds are the most commonly encountered items of this type. Therefore, they have been assigned their own line (Line 10) on Form 1040. If you claimed state and local income taxes as an itemized your deduction in the year to which the refund applies, you may need to report the refund as income on Line 10. If you did not itemize, or you claimed a sales tax deduction instead of the state and local income tax deduction, you don't have to report the refund since you didn't gain any tax benefit from it. This is also true if you did not receive a tax benefit for the state and local income tax deduction because of an alternative minimum tax adjustment or your itemized deductions were phased-out. The taxable portion of the state refund may also be adjusted for any overpayment applied to the following year’s tax estimates. Federal tax refunds are not reported because you cannot claim an itemized deduction for your federal taxes.

This rule -- that you must report the refund or recovery only if you got some tax benefit from it in a previous year -- applies generally to all types of refunds and recoveries, except that recoveries other than state and local tax refunds, credits and offsets are reported on Line 21 of Form 1040.

You only have to report recoveries of items to the extent that they helped your itemized deductions to exceed the standard deduction for the year in question.

Example In 2013, your filing status was single, which would have qualified you for a standard deduction of $6,100. Instead, you claimed itemized deductions of $6,500. In 2014, you receive a $1,000 refund of state income tax. Since your itemized deductions minus your standard deduction was $400, you must report $400 of the recovery as income. The remaining $600 of the recovery is not taxable.

If your deduction for the item was less than the amount you recovered, you only have to report a taxable recovery for the amount that you had actually deducted.

Example In 2013, your unreimbursed employee business expenses were $1,000, with adjusted gross income of $40,000. There is a 2 percent of adjusted gross income limitation on miscellaneous deductions (including employee business expenses). So, you had to subtract $40,000 x .02 = $800 from the expense amount, to arrive at an allowable deduction of $200. In early 2014, your employer reimbursed you for $300 of your business expenses. The amount that must be included in income is limited to the amount you deducted, or $200.

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