Why is a tax refund from last year considered taxable income this year?

Question

So, I'm not looking for specific tax advice because I've already filed my 2006 taxes.

But I'm still left with wondering what the answer is to this question.

We received a refund in 2006 from our 2005 taxes. Now, when filing our 2006 taxes, we're supposed to declare the refund as taxable income.

Why is that? It seems like it's double taxation. (I realize that double taxation happens all the time...look at the death tax!) But still, can anyone explain this to me? Please cite your sources. Thank you.

Answer 1

If you itemized deductions in 2005 and took a deduction for state income taxes paid, your STATE income tax refund is taxable income. The reason is that you took a deduction for the state taxes paid and withheld and the refund is a reduction of that tax liability so it has to be taxed.

If you did NOT itemize deductions in 2005, that refund is NOT taxable and you should NOT claim it as taxable income.

Federal tax refunds are NEVER taxable income, since Federal taxes are not deductible in any case.

If you listed your state refund as taxable income but didn't itemize for 2005, you made a mistake and should file an amended return. Same if you listed your Federal refund as income.

Answer 2

State Tax Refund Taxable

Answer 3

State Refund Taxable

Answer 4

Since you itemized 2005 taxes, only your state tax refund will be considered taxable in the 2006. Remember you deducted state income taxes in 2005 as part of the itemized deduction and they gave a refund as well. So there is a small mis match and irs is closing that gap by making you to pay taxes on your state tax refund.

Answer 5

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RE:
Why is a tax refund from last year considered taxable income this year?
So, I'm not looking for specific tax advice because I've already filed my 2006 taxes.

But I'm still left with wondering what the answer is to this question.

We received a refund in 2006 from our 2005 taxes. Now, when filing our 2006 taxes, we're supposed to declare the...

Answer 6

The refund is only taxable if you itemized deductions last year and claimed the taxes withheld as a deduction. Because your deduction was for more than the actual taxes, you have to claim the difference as income. Only state and local taxes are deductible and only those refunds are taxable. Federal refunds are never claimed.

Answer 7

Your 2005 federal (IRS) refund is not taxable income for 2006, but any 2005 STATE tax refund MIGHT be reportable on the 2006 federal return, if you itemized for 2005.
See the 1040 Instructions for a worksheet to determine how much, if any, should be reported.

Answer 8

tax refund year considered taxable income year

Answer 9

your state refund is taxable the next year because you used it as a deduction.

We had clients where there refund WASN'T taxable. Their deductions made it so their state tax wasn't a deduction to them on the federal. They didn't get a benefit from the taxes paid. Since they didn't get a benefit, the refund wasn't taxable. We had to respond to the IRS on several of these clients.

BTW, don't listen to "Oh Boy." He's wrong

Answer 10

A federal tax refund is NOT considered income the next year. State or local might be. If you itemized the previous year and subtracted the amount paid, claiming the refund as income just puts back what you deducted the previous year - otherwise it would escape taxes all together. If you didn't itemize the previous year, then you don't claim it as income.