IRS Guidance on Determining Amount of Taxable State Tax Refund

The IRC section 164(b)(6), adopted as part of the Tax Cuts and Jobs Act, limits an individual’s deduction for the total amount of state and local taxes paid during the calendar year to $10,000 for joint filers.  Many taxpayers have experienced the ill impact this limitation had on their 2018 personal income tax returns.  The IRS issued Rev. Rul. 2019-11 (the “Guidance”) providing guidance on how this limitation impacts when determining the amount of state and local tax refunds that are taxable on their 2019 personal income tax returns.

The Guidance provides that if a taxpayer received a tax benefit from deducting state or local taxes in a prior taxable year and the taxpayer recovers all or a portion of those taxes in the current taxable year, the taxpayer must include in current year gross income the lesser of (1) the difference between the taxpayer’s total itemized deductions taken in the prior year and the amount of itemized deductions the taxpayer would have taken in the prior year had the taxpayer paid the proper amount of state and local tax or (2) the difference between the taxpayer’s itemized deductions taken in the prior year and the standard deduction amount for the prior year, if the taxpayer was not precluded from taking the standard deduction in the prior year.  This holding applies to the recovery of any state or local tax, including state or local income tax and state or local real or personal property tax.

This holding is consistent with the tax benefit rule provided under IRC section 111 which excludes from gross income amounts attributable to the recovery during the tax year of any amount deducted in any prior year to the extent the amount did not reduce the amount of tax imposed.

Please refer to https://www.irs.gov/pub/irs-drop/rr-19-11.pdf for additional detail.