A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). You may also have recoveries of non-itemized deductions such as payments on previously deducted bad debts and recoveries of items for which you previously claimed a tax credit.
Tax benefit rule.
You must include a recovery in your income in the year you receive it to the extent that the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year. For more information, get Publication 525.
Federal income tax refund.
Refunds of federal income taxes are not included in your income because they are never allowed as a deduction from income.
State income tax refund.
If you received a state or local income tax refund (or credit or offset) in 2000, you must include it in income if you deducted the tax in an earlier year. You should receive, Form 1099-G, Certain Government and Qualified State Tuition Program Payments, from the payer by January 31, 2001. The IRS will also receive a copy of the Form 1099-G.
Mortgage interest refund.
If you received a refund or credit in 2000 of mortgage interest paid in an earlier year, the amount should be shown in box 3 of your Form 1098, Mortgage Interest Statement. Do not subtract the refund amount from the interest you paid in 2000. You may have to include it in your income under the rules explained in the following discussions.
Interest on recovery.
Interest on any of the amounts you recover must be reported as interest income in the year received. For example, report any interest you received on state or local income tax refunds on line 8a of Form 1040.
Recovery and expense in same year.
If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and is not reported as income.
Recovery for 2 or more years.
If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata basis, the recovered amount between the years in which you paid it.
This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of your allowable deduction for this item for the current year. For information on how to compute the allocation, see Recoveries in Publication 525.
Itemized Deduction Recoveries
If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you must generally include the full amount of the recovery in your income in the year you receive it.
Where to report.
Enter your state or local income tax refund on line 10 of Form 1040, and the total of all other recoveries as other income on line 21 of Form 1040. You cannot use Form 1040A or Form 1040EZ.
For 1999, you filed a joint return. Your taxable income was $20,000 and you were not entitled to any tax credits. Your standard deduction was $7200, and you had itemized deductions of $9,000. In 2000, you received the following recoveries for amounts deducted on your 1999 return:
None of the recoveries were more than the deductions taken for 1999.
|State and local income tax refund
|Refund of mortgage interest
Because your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($9,000 − 7,200 = $1,800), you must include your total recoveries in your income for 2000. Report the state and local income tax refund of $400 on line 10 of Form 1040 and the balance of your recoveries, $525, on line 21 of Form 1040.
Standard deduction limit.
You are generally allowed to claim the standard deduction if you do not itemize your deductions. Only your itemized deductions that are more than your standard deduction are subject to the recovery rule (unless you are required to itemize your deductions). If your total deductions on the earlier year return were not more than your income for that year, include in your income this year the smaller of:
- Your recoveries, or
- The amount by which your itemized deductions exceeded the standard deduction.
Standard deduction for earlier years.
To determine if amounts recovered in 2000 must be included in your income, you must know the standard deduction for your filing status for the year the deduction was claimed. Standard deduction amounts for 1999, 1998, and 1997 are in Publication 525.
You filed a joint return for 1999 with taxable income of $25,000. Your itemized deductions were $8,700. The standard deduction that you could have claimed was $7,200. In 2000 you recover $2,400 of your 1999 itemized deductions. None of the recoveries were more than the actual deductions for 1999. Include $1,500 of the recoveries in your 2000 income. This is the smaller of your recoveries ($2,400) or the amount by which your itemized deductions were more than the standard deduction ($8,700 − 7,200 = $1,500).
Recovery limited to deduction.
You do not include in your income any amount of your recovery that is more than the amount you deducted in the earlier year. The amount you include in your income is limited to the smaller of:
- The amount deducted on Schedule A (Form 1040), or
- The amount recovered.
During 1999 you paid $1,700 for medical expenses. From this amount you subtracted $1,500, which was 7.5% of your adjusted gross income. Your actual medical expense deduction was $200. In 2000, you received a $500 reimbursement from your medical insurance for your 1999 expenses. The only amount of the $500 reimbursement that must be included in your income for 2000 is $200--the amount actually deducted.
See Recoveries in Publication 525 if:
- You have recoveries of items other than itemized deductions, or
- You received a recovery for an item for which you claimed a tax credit (other than investment credit or foreign tax credit) in a prior year.
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