You might have received a Form 1099-G reporting a state or local income tax refund. If so, your refund isn’t automatically taxable.

If you claimed the state or local income taxes you paid as an itemized deduction on last year’s return, usually your state or local refund is taxable. However, other circumstances might reduce your tax. The difference between these 2 items can reduce the amount of your refund that's taxable:

• Itemized deductions you claimed last year
• Your filing status's standard deduction

To learn more, see "Other Income" in IRS Publication 17: Your Federal Income Tax.

Ex: Gayle is single. On her 2011 federal return, her itemized deductions totaled $5,850, including a $1,230 deduction for her state income tax. She also received a $700 state tax refund for her 2011 state return.

Since she deducted her state income tax on her 2011 federal return, she needs to include the $700 state refund in her total income on her 2012 federal return. However, she only must include the amount that reduced her 2011 taxable income.

To figure out how much of her refund is taxable in 2012, she must subtract the standard deduction for her filing status (single) from her itemized deductions total ($5,850). In 2011, the standard deduction for the single filing status was $5,950 , so:

$5,850 (total itemized deductions) - $5,950 (standard deduction) = $50

So, she must include only $50 of her state income tax refund in her total income on her 2012 federal return.

To learn more, see the State and Local Income Taxes tax tip.