The IRS has provided four examples of the interaction of the new limit on the deduction on state and local taxes (SALT) under Code Sec. 164(b)(6) with the tax benefit rule for refunds under Code Sec. 111. A taxpayer who is impacted by the SALT limit may not be required to include any refund in gross income depending on whether he or she only paid the actual amount of SALT liability. The ruling does not affect tax refunds received in 2018 for tax returns currently being filed.
SALT Deductions and Refunds
For tax years 2018 to 2025, the itemized deduction of SALT on Schedule A (Form 1040) by an individual is limited to $10,000 ($5,000 if married filing separately). For all tax years, SALT refunds received by a taxpayer who itemized deductions in a previous tax year may be included in gross income depending on amount of tax benefit received from the deduction. The key is determining the amount the taxpayer would have deducted had the taxpayer only paid the actual SALT liability.
In one of the examples, a single taxpayer itemizes and claims deductions totaling $15,000 on the taxpayer’s 2018 federal income tax return. A total of $12,000 in state and local taxes is listed on the return, including state and local income taxes of $7,000. Because of the limit, however, the taxpayer’s SALT deduction is only $10,000. In 2019, the taxpayer receives a $750 refund of state income taxes paid in 2018, meaning the taxpayer’s actual 2018 state income tax liability was $6,250 ($7,000 paid minus $750 refund). Accordingly, the taxpayer’s 2018 SALT deduction would still have been $10,000, even if it had been figured based on the actual $6,250 state and local income tax liability for 2018. The taxpayer did not receive a tax benefit on the taxpayer’s 2018 federal income tax return from the taxpayer’s overpayment of state income tax in 2018. Thus, the taxpayer is not required to include the taxpayer’s 2019 state income tax refund on the taxpayer’s 2019 return.