Per IRS Publication 525 Taxable and Nontaxable Income, page 23:
Recoveries
A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of itemized deductions. You may also have recoveries of nonitemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.
State tax refund. If you received a state or local income tax refund (or credit or offset) in 2023, you must generally include it in income if you deducted the tax in an earlier year. The payer should send Form 1099-G to you by January 31, 2024. The IRS will also receive a copy of the Form 1099-G. If you file Form 1040 or 1040-SR, use the worksheet in the 2023 Instructions for Schedule 1 (Form 1040) to figure the amount (if any) to include in your income.
If you could choose to deduct for a tax year either:
the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you didn't choose to deduct for that year
Recovery and expense in same year. If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and isn't reported as income.
Recovery for 2 or more years. If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata basis, the recovered amount between the years in which you paid it. This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of your allowable deduction for this item for the current year.
Example 28 You paid 2022 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2023. You had no state income tax withheld during 2021. In 2023, you received a $400 tax refund based on your 2022 state income tax return. You claimed itemized deductions each year on Schedule A (Form 1040.
You must allocate the $400 refund between 2022 and 2023, the years in which you paid the tax on which the refund is based. You paid 75% ($3,000 รท $4,000) of the estimated tax in 2022, so 75% of the $400 refund, or $300, is for amounts you paid in 2022 and is a recovery item. If all of the $300 is a taxable recovery item, you'll include $300 on Schedule 1 (Form 1040), line 1, for 2023, and attach a copy of your calculation showing why that amount is less than the amount shown on the Form 1099-G you received from the state.
The balance ($100) of the $400 refund is for your January 2024 estimated tax payment. When you figure your deduction for state and local income taxes paid during 2023, you'll reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes paid during 2023 will include the January net amount of $900 ($1,000 - $100), plus any estimated state income taxes paid in 2023 for 2021, and any state income tax withheld during 2023.
TaxAct does not calculate this allocation for state taxes. If the amounts for Prior Year State Income Tax Refund (to be included in taxable income on the current year's return) and the deduction for Prior Year State and Local Estimates Paid After 12/31/2019 need to be adjusted, the taxpayer would need to manually perform this allocation.
To enter the recovery into the TaxAct program, go to our Form 1099-G - Entering State Income Tax Refund in Program FAQ.
To enter the adjusted state and local income tax deduction on Schedule A (Form 1040) Itemized Deductions into the TaxAct program:
Note that any link in the information above is updated each year automatically and will take you to the most recent version of the webpage or document at the time it is accessed.