Is My State Tax Refund Taxable? (Form 1099-G Explained)
Receiving a Form 1099-G can be confusing. Did you just earn more income? It depends heavily on how you filed last year. With the SALT (State and Local Tax) cap raised to $40,400 in 2026, more taxpayers are successfully deducting state taxes. However, this creates a trap: if you deducted the tax last year, the refund you get this year is likely taxable income. Here is the math to determine if you owe the IRS a share of your refund.
1. The Rule: “Tax Benefit Rule”
The IRS logic is simple: If you got a tax break for paying it, you must pay tax when you get it back.
Result: In 2026, the state refunds you $2,000. Since you used that $2,000 to lower your federal taxes last year, the IRS views it as “recovered income.” You must report it.
Standard Deduction: If you took the Standard Deduction, you never claimed the state tax. Thus, the refund is tax-free.
2. Taxable vs. Tax-Free (Checklist)
Your filing status from last year dictates the rule for this year.
| Your Situation (Last Year) | Refund Status | Action |
|---|---|---|
| Standard Deduction | Tax-Free | Do nothing. (Ignore 1099-G Box 2). |
| Itemized Deductions | Taxable* | Report on Schedule 1. (*Most likely). |
| AMT Payer | Likely Free | If AMT disallowed the deduction, refund is free. |
3. Timeline: The 1-Year Lag Effect
State refunds look backward. The refund received in 2026 is based on the 2025 tax return.
| Year | Event | Impact |
|---|---|---|
| Year 1 (Prior Tax Year) |
Deduction | |
| Year 2 (Current Year) |
Refund | |
| Year 2 Filing | Recapture |
4. Strategy: The New $40,400 SALT Cap
The massive increase in the SALT cap changes the math completely.
- Old Rule ($10k Cap): Many people paid $15k but could only deduct $10k. A $2k refund didn’t matter because $13k was still above the cap. (Refund = Tax Free).
- New Rule ($40.4k Cap):
- You pay $15,000 in state tax.
- You deduct the full $15,000 (Under the $40.4k cap).
- You get a $2,000 refund.
- Result: Since you deducted the full amount, the entire $2,000 refund is now Taxable.
- High Income Warning: If your Modified AGI exceeds $505,000, this SALT limit begins to phase out, complicating the calculation further.
5. Warning: Unemployment is Different
Form 1099-G is used for two very different things.
⛔ Box 1 vs. Box 2
Check the box number carefully.
- Box 1 (Unemployment Compensation): This is ALWAYS taxable. You must report it.
- Box 2 (State/Local Refunds): This is the one subject to the Itemized/Standard rule.
- Standard Deduction Update: Remember, you only Itemize if your deductions exceed $16,100 (Single) or $32,200 (Married). Most people will still take the Standard, making Box 2 tax-free.