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04. Why would I have to report my refund as income?

If you itemize deductions on your federal tax return (instead of using the standard deduction), you are allowed to include state income taxes and property taxes paid during the year in your deduction amount. The itemized deduction reduces federal taxable income. Therefore, if any part of the state income tax or property tax included in itemized deductions on the federal return is later refunded by the state, that amount generally has to be reported as taxable income for the year in which the refund is issued. For example: Suppose a taxpayer claimed both state income tax ($2,000) and property taxes ($1,000) as itemized deductions on their 2006 federal return. Then, during 2007, they filed a 2006 Maine income tax return and a 2007 Maine Residents Property Tax Program application and received both income tax ($500) and property tax refunds ($200). In January 2008, MRS reports to the taxpayer and to the IRS the two refunds issued during 2007 totaling $700 ($500 + $200). This means that the taxpayer only paid $1,500 in state income taxes for 2006, rather than the $2,000 claimed and property taxes of $800 rather than the $1,000 claimed. Therefore, the taxpayer will generally be required to report the difference of $700 (the total amount of the refunds) on the federal return for 2007.

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