New IRS Guidance on State and Local Tax Refunds
The Tax Cuts and Jobs Act of 2017 included a $10,000 ($5,000 if married filing separately) cap on the amount of state and local taxes that can be claimed as an itemized deduction on Schedule A of Form 1040. If you itemize deductions that include a deduction for state and local taxes and then subsequently receive a state or local tax refund, you may have to include part or all of the refund as income in the year you receive it. There were some questions about how the new $10,000 cap would affect the amount of any such refund that would be included in income.
In general, if you receive a federal tax benefit from deducting state or local taxes in a prior taxable year and then subsequently recover (receive a refund for) some or all of the state or local taxes you had deducted, you have to do a two-part calculation. The first part of the calculation is to go back and determine what your total itemized deduction amount in the prior year would have been if you had paid the correct amount of state and local taxes and subtract that from the amount you originally claimed. The second part of the calculation is the difference between your itemized deductions taken in the prior year and the standard deduction amount (including adjustments for being blind or age 65 or older) for the prior year, provided that you could have claimed the standard deduction that year. The amount of the state or local refund that needs to be included in your income is the smaller of these two amounts.