IRS rules on treatment of SALT refunds under new deduction cap

Tax Hot Topics newsletter The IRS has issued Rev. Rul. 2019-11 to address uncertainties in determining the portion of state and local tax (SALT) refunds that must be included in gross income following enactment of the SALT deduction limitation.

Under the “tax benefit rule,” taxpayers are generally required to include refunds of state tax that they deducted in the prior year in gross income to the extent those refunds would have reduced prior-year tax liability. The addition of Section 164(b)(6) by the Tax Cuts and Jobs Act, which imposes a $10,000 cap on the SALT deduction for individuals, created some confusion regarding the circumstances that trigger the inclusion of a SALT refund in gross income and how the inclusion amount should be calculated.

The IRS generally holds that an inclusion is required for taxpayers who receive a tax benefit as a result of deducting an overpayment of state and local tax in a prior year and then recovering some or all of that overpayment through a refund in the current year. The amount of the inclusion is determined as the lesser of these two scenarios:

  • The difference between the taxpayer’s actual itemized deductions in the prior year and the amount the taxpayer would have taken as an itemized deduction had they not overpaid their SALT liability
  • The difference between the taxpayer’s prior-year itemized deductions and the prior-year standard deduction, provided the taxpayer is eligible for the standard deduction.

The ruling includes four examples illustrating different ways SALT refunds, the SALT deduction limitation, and the tax benefit rule interact, as well as how the gross income inclusion, if any, is determined in each scenario. The holding applies to the refund of any state or local tax.

David Auclair
Managing Principal
Washington National Tax Office
T +1 202 521 1515
Shamik Trivedi
Senior Manager
Washington National Tax Office
T +1 202 521 1511

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