Here's When the IRS Might Consider Your Tax Refund as Income

Tax refunds are only considered income in certain state tax refund circumstances. Find out more about when your tax refund might be considered income.

Kathryn Underwood - Author

Jan. 16 2023, Updated 10:59 a.m. ET

Income Tax

Tax laws and regulations can be a minefield of ever-changing information. The rules surrounding tax refunds are no exception. Because the IRS seems to be always modifying its tax refund rules, it can be difficult to understand when you might be entitled to a refund for certain deductions or if your tax refund will be considered as income.

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If you’re looking to gain a better understanding of what tax refunds are and when you might have to pay tax on them, keep reading!

What is a tax refund?

A tax refund
Source: Getty Images

The IRS collects income taxes each year. A tax refund is simply “a return of money paid that is more than what is actually owed for taxes,” according to Merriam-Webster.

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Regular employees will have taxes deducted from each paycheck based on how they fill out their Form W-4. Often, this can lead to overpaying on their taxes, which results in a refund. Self-employed individuals may also receive a tax refund due to overestimating their quarterly tax payments throughout the fiscal year. 

Having a professional prepare your taxes may help avoid missed deductions, overpayment, and other issues.

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A man doing his taxes
Source: Pixabay

Many Americans like receiving a tax refund in April. However, getting a refund means that you’ve been loaning your money to the federal government. Some people prefer to overpay to avoid the risk of underpaying and owing money at the end of the year. 

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The IRS states that over 90 percent of refunds are issued within 21 days of processing a tax return. Some taxpayers elect to receive a paper check for the refund. However, around eight in 10 people choose to e-file and receive a direct deposit. The federal government processed nearly 261 million tax refunds for fiscal 2021, totaling more than $1.1 trillion in payments.

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Is a tax refund considered income?

It can be confusing to determine exactly what the IRS categorizes as taxable income. 

A tax refund on your federal income tax isn't considered income. Taxpayers don't need to worry about paying more taxes on the refund they received since it's technically the taxpayer’s money to begin with. 

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The refunds you receive from your state income tax returns may be considered income. It depends on whether you deducted state and local income taxes in your tax returns the previous year.

Using a standard deduction instead of an itemized one with deductions for state and local income taxes means that the refund isn't counted as income.

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A calculator and money in the clamp
Source: Pixabay

Is a tax refund taxable?

The IRS doesn't require you to report your federal tax refund as taxable income. However, the rules are different for state income taxes. 

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If you elected to take an itemized deduction on your taxes the previous year, part or all of that refund may need to be reported as income the following year. Individuals can find out information for their specific situation on the IRS website.

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If you didn't itemize your deductions and took a standard deduction, the resulting tax refund isn't taxable by the government. Another factor to recognize is that if you deducted state and local sales tax instead of income tax, your tax refund isn't taxable, according to H&R Block.

When do you pay taxes on a tax refund?

For your state income tax refund, any taxes that you owe will be due the tax year immediately following the year the refund was issued. So, if you received a state income tax refund for 2021, you may need to report the refund as income on your 2022 tax returns.

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