I hadn't noticed this, and maybe some of you haven't either. Traditionally, for a recovery (including state income tax refunds), we're used to thinking that if a [cash basis*] taxpayer got a tax benefit from a deduction, he must include the refund as income in the subsequent year. However, the IRS threw in a "curve ball" starting with the state sales tax deduction. From Pub 525 (2010):
"If you could choose to deduct for a tax year either: - State and local income taxes, or - State and local general sales taxes, then the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you did not choose to deduct for that year.
"Example 1. For 2009 you can choose an $11,000 state income tax deduction or a $10,000 state general sales tax deduction. You choose to deduct the state income tax. In 2010 you receive a $2,500 state income tax refund. The maximum refund that you may have to include in income is $1,000, since you could have deducted $10,000 in state general sales tax."
This means that for every taxpayer, we now have to figure out the state sales tax deduction even when the income tax deduction is higher. Does your software do that? Maybe not, and especially not if one doesn't have a package that carries from year to year.
- - An accrual basis taxpayer would not be deducting the amount paid in, only the amount owed, so his refund would not be a recovery.