Some people look forward to tax time because they receive a tax refund when they file. If you receive a federal tax refund, you never have to worry about paying taxes on it the following year; however, you may have to pay taxes on your state refunds, depending on how you handled deductions.
Definition of Refund
A tax refund is the refund of all taxes that you already paid for the year. Thus, your refund is not income, and you do not have to report it as income on your next year's taxes. If the IRS were to tax you on your refund, it would create an endless cycle in which the IRS taxed you, refunded your taxes and then taxed you again. For this reason, you should not report your federal tax refunds as income.
State tax refunds are sometimes considered income on your federal taxes. If you itemized your deductions and deducted your state taxes from your federal taxable income, the following year you must report any state tax refund as income on your federal taxes. However, if you took a standard deduction, you do not need to report your state taxes as income. The reason for this rule is that if you deducted state taxes and then your state taxes were refunded, the deduction would not be valid.
No Federal Deductions
Another reason that you do not have to report federal income tax refunds as income on your following year's return is that there are no federal deductions involving the amount of tax you were charged. For example, you cannot deduct the taxes you owe from your taxable income. Thus, you will never be in a situation where you deducted federal taxes and then received those taxes back in the form of a tax refund.
You only have to deduct the amount of state income tax refund that is greater than the tax you could have deducted. For example, if you have the option of deducting $11,000 in sales taxes but instead deducted $10,000 in income taxes, you only have to report $1,000 of your refund as taxable income, as that is the difference between the two possible deductions.