Overpaying State Income Tax and 1099-G

[Jim T.]

If one overpays the state income tax, they receive a 1099-G the following year for the refund amount. This makes sense since  you were able to deduct all that was deducted rather than just what was ultimately owed. If your highest tax bracket didn't change from one year to another,  it is pretty much a wash. 

However, now that the state income tax is limited, you may not be able to deduct all the state income that was deducted. If you then receive a 1099-G, you will be including income that was not deducted the previous year. Let me use an example to hopefully make clear what I am trying to say (Property tax kept out of this for simplification)

2018 - total state income deducted = $12,000. You are able to deduct only $10,000 for the 2018 tax year. After you complete your state returns, it is determined that the state tax due is $11,000.   You overpaid by $1,000 and that $1,000 is given to you as a refund. If we are playing by the old rules, you will receive a 1099-G for $1,000 to be included as income for 2019 tax year. Did you just get hosed? You paid $11,000 in state taxes, deducted $10,000 in 2018, and received a 1099-G for $1,000 (which will be added to your income next year). 

Let's say you only had $10,000 deducted for state taxes. You deduct the entire $10,000. Turns out you owe an additional $1,000. That's fine, you write a check to the state for $1,000.  You are still paying the same $11,000 to the state as the previous example but next year you don't get the $1,000 1099-G. It sounds to me like you come out ahead this way. If this is right, lesson learned, don't overpay state income taxes. 

[Logan Allec]

@Jim T. You only include the 1099-G amount into income to the extent you received a tax benefit for it.  This has always been the rule.

Where it came into play most often was for taxpayers subject to the AMT.  Many taxpayers subject to the AMT did not receive any benefit for state taxes paid, or only a partial benefit, in the year paid, and so their 1099-G amount would not be included in income, or only partially included in income, in the year the refund was received.

It will be a similar story for those in the situation that you describe.

Tax preparers, if they're not lazy, should not blindly pick up the 1099-G amount as income but should go back to determine exactly how much benefit the taxpayer received for state taxes paid.  Problem is that many tax preparers are lazy and miss this, and many DIY'ers miss this as well and end up paying tax on something they don't have to, i.e., the portion of their refund that they never received a tax benefit on to begin with.