An Income Tax Refund May Count as Income — Here’s How

The IRS tax season started on January 24, 2022, and the agency claims that most refunds are issued within 21 days of it accepting the filed return. The IRS is severely backlogged due to the COVID-19 pandemic and the resulting shortage of staff and one-off adjustments, which take longer to account for. However, many people have already started getting refund checks. Many people have questions about taxes, but one doubt creeps into people’s minds. Does a tax refund count as income?

A taxpayer gets a refund if an excess amount was paid to the federal or state government. It isn't something that the government is paying you because it's part of the taxes that you overpaid. The refund is essentially an interest-free loan you're offering to the government. You should fill out W-4 as accurately as possible to avoid paying penalties and keep as much of your earnings as you can instead of loaning it to the government for part of the year.

In 2021, 128 million Americans (about 70 percent of taxpayers) received an average refund of $2,775, according to the IRS. The average refund was about 3.1 percent higher than the year before.

There are three broad aspects to this question about whether a tax refund should be counted as income.

A federal tax refund isn't included on a federal tax return, so it isn't counted as income.

Whether or not a state tax refund is counted as income on a federal tax return depends on whether you took an itemized deduction for the tax that was later refunded. There are two ways, it could be treated:

• You don't need to report any of the refund as income if you didn’t itemize your deductions on your federal tax return for the tax year that generated the refund.
• If you took an itemized deduction in an earlier year for taxes paid that were later refunded, you may have to include all or part of the refund as income on your tax return. The IRS recommends using Worksheet 2, Recoveries of Itemized Deductions in Publication 525, Taxable and Nontaxable Income to determine the taxable amount of your state or local refunds to report on your tax return.

Another aspect to consider is the interest earned on refunds. A long-standing law requires the IRS to pay interest to those who receive their refunds late. Usually, 45 days after the filing date deadline. This is the same way taxpayers have to pay interest on any outstanding obligations to the IRS. Now, coming back to the question of counting it as income, yes, it does count as taxable income and should be reported on your return. Similarly, the interest from state governments is also considered income and is therefore taxable.