Question

Why must the state tax refund received for taxes paid in the prior year be included as taxable income in the current year when a taxpayer is deducting state & local taxes in both years?

Answer 1

Let us understand with an example and then try to relate it to the question asked.

Imagine a real life situation where a person even after being offered help declines it and then complains that he/she has to do everything alone because there's no one to help him/her. Do you see the problem? The complaints are totally unfair. This person can't have it both ways.

This is how the state tax refund received for taxes paid in prior year works.

The rule, in my opinion, is fair and logical. If a taxpayer has claimed state tax paid in the federal tax return, that is, he/she has itemized the taxes paid and claimed them as deduction, then in future if the same taxes are received as refunds, the refunds shall become taxable. This it he reason why in a particular year state taxes paid in current year can be claimed as deduction and the refund received from previous years be included in taxable income.