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When to pay income tax on state refund

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Q: I started my own consulting business in 2004 after I lost my corporate job. Instead of accepting my state tax refund from 2004, I chose to apply it to my state taxes for 2005. Do I owe federal income tax on that amount? N.H., Tenafly, N.J.

A: Yes. Generally, if you receive a refund of state and local taxes, you must include the refund in the year in which you receive it if you itemized your deductions in the prior year. This includes amounts you receive which you then apply to tax liability for another year or amounts that were not figured correctly on the original return. Tip: You don't need to report the state tax refund as income if you didn't deduct the payment in the past or intend to deduct it in the current year.

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