What Is Double Taxation and How To Avoid It

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Receiving a state tax refund can feel like a financial windfall, but it’s important to understand the implications it may have on your federal taxes.

In certain situations, your state refund may be subjected to federal taxes. Whether or not your refund is taxable depends on how you filed your taxes and what deductions you claimed, which affects whether you paid taxes on the money you’re refunded. Here’s what you need to know to navigate this scenario wisely and potentially avoid paying more to the government than necessary.

Is a State Tax Refund Taxable Income?

State refunds are only subjected to federal taxes in specific situations. Whether your state refund is federally taxable depends on what you claimed on your taxes in the previous tax year. Because most people claim the standard deduction, they do not need to pay taxes on their state refunds.

Let’s look at a few different scenarios and what they mean for your state tax refund and related federal taxes.

You Itemized Deductions and Wrote Off State Tax Payments

Your state refund is taxable if you itemized your deductions and deducted payments for state tax in the previous tax year. Many people choose to write off their state tax payments to lower their federal taxable income and potentially fall into a lower federal tax bracket. 

If you choose to write off your income tax, you may not need to report the entire state refund as income. You only have to report the amount you received that is more than the amount you deducted in the previous year. For example, if you deducted $1,500 in state taxes last year, but your state refund this year was $2,000, you only need to report a tax refund of $500 on your federal income tax return.

You Itemized Deductions and Wrote Off State and Local Sales Tax

There’s one scenario where you can itemize deductions without owing taxes on your state tax refund. Instead of itemizing your tax return and deducting income taxes, you can deduct state and local sales taxes.

If you only deduct the sales taxes, your refund won’t be federally taxable. However, if you deduct income taxes, then your state refund is subjected to federal taxes.

You Took a Standard Deduction

The situation is even simpler if you didn’t itemize your return. Instead, if you chose the standard deduction on your federal income tax return, you won’t owe any federal income tax on your state tax refund. It’s very common to choose the standard deduction — according to the IRS, in 2021, 90% of individuals claimed the standard deduction instead of itemizing their deductions, meaning most taxpayers aren’t responsible for paying tax on their state refunds.

For example, if you deducted your state and local income taxes in your 2024 return and received a state tax refund, your state refund is regarded as taxable when you file your 2025 taxes. But if you took a standard deduction when you filed your 2024 taxes and received a state refund, that refund is not taxable when you file your 2025 taxes.

In this second scenario, the tax refund isn’t increasing your wealth; it’s a refund of an overpayment, so the IRS doesn’t consider it taxable.

How To Determine If Your State Refund is Taxable

To determine if your state refund is taxable, you will need to determine if you itemized your tax refund last year. If you can’t remember whether you itemized your taxes last year, there are two ways to tell:

• Look through the previous year’s tax records for a Schedule A. This form is used to file itemized deductions, so if you don’t have the form, you took the standard deduction, and your state refund is tax-exempt.
• Review line 12 of your Form 1040 from the previous tax year. If the number in line 12 matches the standard deduction amount for your filing status — listed in the left-hand margin of the form — you did not itemize, and your state refund is tax-exempt.
• Determine if you deducted sales taxes or income taxes. If you follow the above steps and determine you itemized your return, then you will need to determine if you deducted sales taxes or state income tax. Find your Schedule A and look at line 5a. If the box on line 5a is checked, it indicates that you deducted sales tax, and your state tax refund isn’t federally taxable. If the box isn’t checked, it indicates that you itemized your state income tax, and your state refund is taxable.

If you used a tax professional to help you prepare your taxes, they can also tell you if you itemized your deductions. Even if you prepared your taxes yourself, a tax professional will be able to look at your tax return and tell you whether you itemized your deductions and if your state tax refund is taxable.

How To Avoid Paying Taxes on Your State Refund

There are two ways to avoid paying taxes on your state refund. 

1. Take the Standard Deduction

The most common strategy is to take the standard direction instead of itemizing your tax deductions.

2. Itemize Your Deductions, But Don’t Deduct State Taxes

If you need to itemize your federal income tax return deductions, opt not to itemize any state taxes paid during that tax year. You can still deduct any sales tax paid.

How To Report Your State Refund

If you used the same tax software program this year to complete last year’s taxes, it may remember and self-populate your taxable refund. 

Otherwise, gather the following:

• The Form 1099-G for any state that sent you a refund in the tax year you’re filing for
• Your tax records from the previous tax year
• The previous year’s federal Form 1040 and Schedule A if you itemized deductions that year
• The current tax year’s Form 1040 with Schedule A Worksheet
• The current tax year’s Worksheet 2, “Recoveries of Itemized Deductions”

Check your previous tax year’s paperwork first. If you see that you itemized your state taxes, use your Form 1099-G to fill out your current tax year’s Form 1040 using the worksheets to help. The IRS provides detailed instructions on how to complete the worksheet. You will need to input:

• Your prior year’s state tax refunds
• Any state tax withheld and state estimated payments made
• Any calculated sales tax that wasn’t deducted on your prior year’s Schedule A

You can find this information on your prior year’s tax return.

The completed worksheet will calculate the portion of the refund that is taxable. This is the amount that you will need to report to the IRS when you file your taxes for the current year. You will need to enter this figure on Line 10, “taxable refund,” on Form 1040.

If these steps are overwhelming, tax software programs may guide you through the process and populate the calculations for you. You can also consult a tax professional for help.

Final Take

The best way to ensure you won’t need to pay federal income tax on your state refund is to file your taxes using the standard deduction. If you must itemize your deductions, deduct any state sales tax you paid instead of the state and local taxes.

Make certain to keep a record of your taxes from year to year so you can quickly determine if you owe federal income tax on your state deduction.

Jen Pedrozo contributed to the reporting of this article.

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