Allocating Estimated Payments for Taxable Refund Calculations

When a taxpayer receives a refund of state income taxes, and the taxpayer took a deduction on their federal tax return, and some of the payments made to the state were estimated payments that may have been made in a different calendar year … well, it can require some math to determine the taxable refund and the deductible portion of the estimated payment.

Let’s use an example to illustrate.

Setup

In 2016, the taxpayer:

1. Paid \$4,194 of state taxes. This includes withholdings and estimated payments.
2. The \$4,194 amount includes \$990 of estimated payments made in January 2017.
3. Total amount deducted on Schedule A as an itemized deduction for state taxes is \$3,204 (the actual amount of state taxes paid in 2016; remember, \$990 was paid as an estimated payment in January 2017).
4. The taxpayer received a 2016 state refund of \$982

In this situation, there are 2 calculations to make: 1) the amount of the \$982 state refund that’s included in income in 2017, and 2) the amount of the \$990 estimated payment made in January 2017 that’s deductible in 2017.

Step 1: Calculate the Ratio

If we look up above in the setup, we see that the taxpayer made \$4,194 of state tax payments that were credited to their 2016 state taxes. This includes \$990 of estimated payments made in January 2017. They received a 2016 state refund fo \$982.

To calculate how much of the refund is included on their 2017 federal tax return, we start by figuring the ratio of 2016 state tax payments made in 2016 vs. payments made in 2017.

The taxpayer made \$990 of state tax payments in 2017 (credited to 2016), so we take \$990 / \$4,194 = .2361.

Step 2: More Math

So, how much of the \$982 refund is counted as income in 2017?

First, take \$982 x .2361 = \$232.

Then, take \$982 – \$232 = \$750. This is the amount of refund potentially included in income in 2017. I say “potentially” because there’s another step here, which is calculating the “tax benefit” rule to determine how much of the \$750 would be included in income.

Then, we need to calculate how much of the \$990 estimated payment made in January 2017 can be deducted on the 2017 return. That’s calculated as: \$990 – \$232 = \$758.

Conclusion

• Amount of refund potentially included in income in 2017: \$750
• Amount of January 2017 state estimated tax payments deductible in 2017: \$758