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If you recover or receive back an amount that you had already deducted on a prior year's return, you generally must report the recovered amount as income in the year you receive it. This rule saves you the trouble of having to file an amended tax return for the prior year.
State or local income tax refunds are the most commonly encountered items of this type. Therefore, they have been assigned their own line (Line 10) on Form 1040. If you itemized your deductions in the year to which the refund applies, you must report the refund as income on Line 10. If you did not itemize, you don't have to report the refund since you didn't gain any tax benefit from it. Federal tax refunds are not reported because you cannot claim an itemized deduction for your federal taxes.
This rule -- that you must report the refund or recovery only if you got some tax benefit from it in a previous year -- applies generally to all types of refunds and recoveries, except that recoveries other than state and local tax refunds, credits and offsets are reported on Line 21 of Form 1040.
You only have to report recoveries of items to the extent that they helped your itemized deductions to exceed the standard deduction for the year in question.
If your deduction for the item was less than the amount you recovered, you only have to report a taxable recovery for the amount that you had actually deducted.