Around the end of January every year, most of people will receive a “post card” like this from the state. “What is it? What should I do about it”, many people would ask.
The “post card”, offically form 1099-G, shows the amount the state refuned you in the past year. It is not bill that you need to pay, nor the money you are going to receive. It is only applicable to people who deducted state tax as part of the itemized deduction last year.
If you have paid $5,000 state tax, deducted the same amount from federal return as part of the itemized deduction, and then the state refunded you $1,000, you obviously over deducted as your actual state tax liability is $4,000. To deduct the correct amount in the same year not only presents a mathematical difficulty due to federal and state tax interdependency, but also not right as you have not received the state refund until next year. Therefore you deduct the state tax you actually paid instead of what you owed, and add the refund when you receive it on line 10 of Schedule 1.
Usually you add the full refund amount. In special cases you add partial amount or nothing at all. For example, if you hit alternative minimum tax (AMT), that you have claimed the extra state tax (the state refund amount) had zero benefit, you do not add the refund as income because you should not penalized for something you had not received a benefit.
Another example is illustrated by the following diagram:
In this case, the itemized deduction and standard deduction are very close that without the state tax paid the itemized deduction is below the standard deduction, and it exceed the standard deduction when added. The extra state tax claimed does not get the full benefit as compared with standard deduction, so only the part of the refund over the standard deduction will be added.
The tax law is not a bunch of random rules, it has its internal logic. Preparing a tax return is not just data entry. Many years after, I still vividly remember the innocent look of a senior accountant who was so puzzled by that the refund to be added as income is less than the refund received.