Although there are simpler options available to people with very uncomplicated tax situations, most people putting forth a conscious effort to maximize their deductions or returns, or just minimize the amount owed, use the 1040 Tax Form (the “long form”).
There are some U.S. citizens and residents that do not have to file income tax returns, mostly those making virtually no money and receiving none through alternative channels, but the overwhelming majority of people do have to file a 1040 tax form, or one of its variants, every year.
Making mistakes on your 1040 tax form can be a real problem, resulting in additional amounts owed, fines and penalties, and an increased likelihood of being audited. Therefore, it is prudent to avoid mistakes whenever it is possible, however this can be rather difficult.
Many of the line items on the form can be quite confusing and it is easy to make mistakes. Not surprisingly, some line items are easier to make a mistake on than others, and Line 10 is one of those items that people frequently make a mistake on. Line 10 relates to how much of your local or state tax returns count as taxable income to the federal government and it can be quite confusing.
Generally speaking, if you did not itemize your tax deductions for the year that you received the local or state tax refund, your refund is not deductible. It is also not deductible if in your deductions you chose to deduct your state and local sales taxes instead of your state and local income taxes. However, if you do not meet one or the other of these requirements, part or all of your state and local tax refund maybe taxable income as far as the federal government is concerned. Since every state and many localities have their own unique tax systems that are not directly related to the federal system, all of this can become very confusing.
It is simple enough for individuals that do not regularly itemize their deductions, which are usually people making smaller salaries or wages. However, since most individuals do not save all their receipts to document sales tax expenses, very few opt to deduct state and local sales tax.
This essentially means that almost anyone that itemized their deductions on their federal income tax for years in which they received state or local tax refunds, at least part of these refunds will be considered taxable income by the federal government.