How to Properly Calculate Taxability of a Federal Refund on Your Iowa Taxes

Residents of Iowa are taxed on their federal tax refunds. This is a primary complaint I hear from clients, especially people who have moved here from other states that don’t engage in this practice.

The full amount of the federal refund is not always taxable. In true Iowa tax fashion, you must perform recalculations. Yay! And also in true Iowa tax fashion, there might be times when you receive a federal refund but can actually take a deduction for federal taxes paid, instead.

Math Class is in Session

To figure how much of your federal refund is taxable, you have to look at your prior-year federal return to see if you claimed any refundable credits. For example, the Earned Income Credit, Making Work Pay Credit, Additional Child Tax Credit, Adoption Credit (for 2010 and 2011 only), etc. Basically, any credit that appears in the “Payments” section on page 2 of Form 1040.

Iowa does not tax you on refundable credits received. So you have to perform calculations to determine what to put on your Iowa return.

Example:

Joe received a federal refund of $1,000 in 2010. Included in this amount was a $400 Making Work Pay Credit (a refundable credit). Iowa will tax Joe on $600 of his refund ($1,000 minus $400) on his 2011 tax return.

This can result in you getting to take a deduction for additional federal taxes paid, even if you got a federal refund.

Example:

Joe received a federal refund of $300 in 2010. This included a $400 Making Work Pay Credit (a refundable credit). Joe can take a deduction of $100 on his 2011 Iowa tax return ($300 minus $400).

Notes

  • You use your prior-year federal refund amount, not your current-year refund amount (so you will use your 2010 refund amount on your 2011 Iowa return).
  • Essentially, Iowa only taxes you on the amount of federal refund attributable to excess federal withholding. This is because Iowa allows a current-year deduction for federal taxes paid. If you receive a refund because of too much withholding, Iowa “recaptures” the excess the following year.

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“This blog post, along with comments that may follow, should not be considered tax advice. Before you make final tax or financial decisions, please secure a professional tax advisor to give you advice about your unique situation. To secure Jason as your accountant, please click on the ‘Services’ link at the top of the page.”