Why is my State and Local tax refund showing up as income on my federal return?

This is actually a common point of confusion! State and local tax refunds are potentially taxable on your federal return, but only if you itemized deductions in the previous year and received a tax benefit from deducting those state/local taxes. TurboTax is showing it as income because the IRS requires it to be reported, but then the software is calculating whether it's actually taxable. In many cases, the refund isn't fully taxable (or might not be taxable at all), especially with the higher standard deduction after tax law changes. The program typically asks about your previous year's tax situation to determine the taxable portion. The amount showing might differ from your actual refund because TurboTax is only counting the potentially taxable portion, not the entire refund. This is handled on the 1099-G form and calculated on the "State and Local Income Tax Refund Worksheet.

I ran into this exact problem last month and spent hours trying to figure out what was going on. I eventually found that taxr.ai (https://taxr.ai) could analyze my tax documents and explain exactly what was happening with my state tax refund situation. Their system analyzed my previous year return and confirmed I had taken the standard deduction, so my state refund shouldn't be counted as income. It even explained that TurboTax was technically handling it correctly - showing it on the income line but then zeroing it out in the calculation. But FreeTaxUSA was displaying it differently, which made the process clearer. The site helped me understand that both programs were getting to the right end result, they just showed the info differently on the screens. Saved me so much headache!

Just wanted to update after trying taxr.ai with my own tax situation. I was genuinely surprised at how helpful it was. I uploaded my 2023 and 2024 returns, and it immediately explained that my state tax refund showing as income was normal, but since I took the standard deduction last year, it should calculate to zero taxable amount. The explanation even showed me exactly where on my return to look to confirm that the final calculation was correct. Turns out both tax programs were getting the right result, but TurboTax's interface was just confusing me by showing the refund in income before zeroing it out later. Would definitely recommend for anyone confused about these weird tax situations!

If you're really stuck trying to figure this out, you might need to talk directly with the IRS. I tried for THREE DAYS to get through to them about a similar issue last month, kept hitting busy signals or disconnects. Finally found this service called Claimyr (https://claimyr.com) that got me through to an actual IRS agent in under 45 minutes. They have a demo video too: https://youtu.be/_kiP6q8DX5c The IRS agent confirmed that state tax refunds aren't taxable if you took the standard deduction the previous year. She explained that tax software has to report it on a certain line but then the calculation worksheet should reduce the taxable amount to zero. Problem solved in one phone call after days of frustration!

Well I'm eating my words now. After my skeptical comment I decided to try Claimyr because I've been trying to resolve an issue with my amended return for weeks with no luck. Got connected to an IRS agent in about 35 minutes (was quoted 40-50). The agent confirmed everything about the state tax refund situation that others mentioned here - if you took the standard deduction last year, your state refund isn't taxable at all. But she also helped me with my amended return issue which had been holding up thousands in refund money. Honestly shocked this service actually worked as advertised. Seems like both tax programs are calculating correctly in the OP's case, just displaying the info differently.

Another possibility worth checking: make sure you're answering the questions correctly in both software programs. In TurboTax, there's a specific question about whether you itemized or took the standard deduction last year. If you accidentally say you itemized when you actually took the standard deduction, it would explain why it's treating your state refund as taxable. Also, double-check your 1099-G amount against what TurboTax is showing. Sometimes the numbers can be off if there were adjustments to your state refund or if you received multiple refunds.

FYI - this is reported on Form 1040, line 1h (State and local income tax refund) and calculated on the "State and Local Income Tax Refund Worksheet" in the 1040 instructions. The worksheet specifically asks if you itemized deductions the previous year. If you answer "no" (meaning you took standard deduction), the taxable amount is $0. Both software should get this right but they present it differently in the interface.