If you are itemizing your deductions, the IRS will generally allow you to take a deduction for state and local taxes that you paid during the tax year. This deduction can even include amounts that you may have paid toward a prior year's tax return. Generally, you can include:
State and local income taxes paid during the year for a prior year.
- Example: Last year when you filed your New York return, instead of getting a refund, you had to pay in $300. You ended up paying late, so the state assessed penalties and interest totalling $50. The $300 that you paid in with your return last year to the state of New York for taxes can be used as a deduction on your federal return this year. However, the $50 that you paid for penalties and interest could not be included in your deduction.
State and local estimated tax payments made during the tax year (Example 1 below), including any part of a prior year refund that you chose to have credited to your next year's state or local income taxes (Example 2 below).
- Example 1: You own your own business, so you have to make estimated payments during the year to cover your tax liability. In January of 2010, you closed out your 2009 records for your business. In doing so, you realized that your fourth quarter (October of 2009 thru December of 2009) had a profit. To cover the taxes that would be due on your profit, you made an estimated payment of $1000 in January of 2010. You are now filing your 2010 return. The $1000 that you paid in January of 2010 can be used as a deduction on your 2010 return, even though the amount was actually paid for tax year 2009.
- Example 2: Last year when you filed your Illinois return, you were due a refund of $1000. Rather than having the full $1000 refunded to you, you chose to only receive $600 as a refund and to apply the other $400 of the refund to your tax bill for the following year (this year). In addition to getting credit for the $400 on your state return this year, you can include $400 on your federal return as part of your itemized deductions.