When you recover amounts for which you previously received a tax benefit, such as a deduction or credit, you would generally have to report part or all the recovery as taxable income on your federal income tax return. An example would be a refund of state income tax if you claimed an itemized deduction for the state tax on your federal return the prior year. If you claimed the standard deduction last year, you would not report the state income tax refund as income.
When you receive a state income tax refund you should receive a Form 1099-G. Since the tax benefit you received is the amount by which your itemized deductions exceeded the standard deduction, this is taken into account in determining the amount of the refund that is taxable. You can use the State and Local Income Tax Refund Worksheet in the 1040 Instructions to determine the amount of the refund you have to report as income. If you use tax software to prepare your return, this calculation may be done automatically.
Also, when you can choose to deduct either state and local income taxes or state and local general sales tax, the amount of any refund you receive that has to be included in income is limited to the excess of the deduction you chose to deduct over the deduction you chose not to deduct.
For example, if you claimed a deduction of $12,000 for state and local income taxes last year and could have claimed a deduction of $10,000 for general sales tax, and you received a state income tax refund of $2,500 this year, you would include only $2,000 in income on your federal tax return.
If you had claimed a deduction for actual general sales taxes last year of $10,000, instead of a deduction of $9,000 for state and local income taxes, and this year you return an item you purchased and receive a sales tax refund of $400 and also receive a state income tax refund of $1,000, you would report a recovery of $400 as income. This is less than the excess of the general sales tax deduction of $10,000 over the net state and local income tax deduction of $8,000 ($9,000 minus the refund of $1,000). Since you chose not to deduct state income taxes, you would not have to report the state tax refund as income.
If you receive a refund or credit for mortgage interest you deducted in a prior year, the amount should be reported in box 3 of Form 1098, Mortgage Interest Statement that you receive from the lender. As indicated by the IRS, the refund should not be subtracted from your deduction for mortgage interest for the current year. It may have to be reported separately as income.
If you receive a reimbursement for medical expenses, you should take into account the limit of 7.5% of adjusted gross income. For example, if you had medical expenses of $2,000 last year and 7.5% of your adjusted gross income was $1,500 your deduction was $500. If you received an insurance reimbursement of $700 this year for those expenses, you would report $500 as income, since that was the amount by which your taxable income was reduced last year.
A taxable refund of state and local income taxes is reported on line 10 of Form 1040. Other recoveries would generally be reported on line 21 of Form 1040 as other income. If you receive a refund or recovery in the same year as you incur the expense, you would reduce your deduction or credit and would not report the recovery as income.
1040 Instructions, IRS
Publication 17, Your Federal Income Tax, IRS
Publication 525, Taxable and Nontaxable Income, IRS