IRS Confirms Treatment of State Tax Refunds on 2019 Tax Returns

The IRS has issued Revenue Ruling 2019-11 which outlines how state and local tax refunds will be treated when they arise from years subject to the $10,000 cap on deducting personal state and local income and property taxes imposed by IRC §164(b)(6) added by the Tax Cuts and Jobs Act (TCJA).  The treatment agrees with the treatment outlined in our March 1, 2019 article on the matter (“Tax Benefit Rule of §111 Should Shield State Tax Refunds For Taxpayers Over the SALT Limit”, Current Federal Tax Developments website, March 1, 2019).

As was noted in the referenced article, the tax benefit rule of §111(a) requires determining the amount of such deduction that was later refunded could have been removed from the prior year’s return with no tax effect.  That could be true to the extent:

  • The tax deduction for the prior year was capped at $10,000 by IRC §164(b)(6).  In that case, any refund up to the amount of the disallowed tax deduction on the original return would not generate a tax benefit and, under IRC §111(a), would not be subject to inclusion in income in the received; or

  • Had the refunded amount not been deducted on the original return, the standard deduction would have exceeded the itemized deduction.  In that case, no tax benefit is generated by the refund that is in excess of the amount of the total allowed itemized deductions on the original return in excess of the standard deduction.

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Tax Benefit Rule of §111 Should Shield State Tax Refunds For Taxpayers Over the SALT Limit

This week a number of questions arose in different online tax discussion forums regarding the potential taxability of a state income tax refund for taxpayers where the taxpayers had their state tax deductions limited by the $10,000 limit on such deductions under IRC §164(b)(6).  The question was whether a portion of the refund equal to the refund amounts times the ratio of income taxes to total state and local taxes subject to the $10,000 limit will be considered taxable in 2019.

Some tax software have been providing reports of potentially taxable refunds based on the ratio calculation. The rumors suggest that at least some sources at the IRS have indicated that this prorated refund calculation is what should be reported in 2019. But is such a calculation correct?

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