State refund interest is taxable federal income, but state treatment varies
Interest paid on a state income tax refund is taxable as federal income. The IRS treats it the same way it treats interest from a savings account or bond — it counts toward your federal taxable income for the year you receive it. However, whether that same interest is taxable on your state return depends on which state issued the refund and what that state's rules are.
The key distinction: the federal government taxes the interest no matter what. Your state may or may not. This matters because it affects what you owe when you file your federal return, and potentially what you owe your state.
Key Takeaways
- Interest on state income tax refunds is always taxable federal income and must be reported on your federal return.
- Most states that pay refund interest do not tax that interest on their own state returns, but a few do — check your state's rules.
- The state will report the interest amount to you on a 1099-INT or similar form, and the IRS receives a copy.
- You report federal refund interest on Schedule B (Form 1040) if the amount is $1,500 or less, or on Schedule B if it exceeds that threshold.
- Interest accrues only when a refund is delayed beyond a certain number of days — typically 45 days for federal refunds and 30 to 45 days for state refunds, depending on the state.
How the IRS treats state refund interest
The IRS considers interest paid on any tax refund — federal or state — to be taxable interest income. This is reported on your federal tax return for the year in which you receive the interest payment. If the state sends you a refund of $2,000 plus $45 in interest, the $45 is what gets reported as taxable income on your federal return.
You will receive a Form 1099-INT (or a state equivalent) from the state tax authority showing the interest amount. The state sends a copy to the IRS, so the interest is already in the system when you file. Failing to report it can trigger a mismatch notice from the IRS.
The interest is reported on Schedule B (Form 1040) under "Interest" if you received $1,500 or less in interest from all sources that year. If you received more than $1,500 in total interest, you must file the full Schedule B and list each source separately.
State-by-state rules on taxing refund interest
Most states do not tax interest paid on state income tax refunds. However, a handful of states treat it as taxable income on the state return. The states that typically tax refund interest include Illinois, Iowa, Louisiana, and Missouri, though rules change and vary by the type of refund.
Some states have exceptions: they may not tax interest if the refund itself was not taxable (for example, if you received a refund of taxes withheld but had no tax liability). Other states tax the interest only if it exceeds a certain threshold, such as $1.
The safest approach is to check your state's tax authority website or the instructions that came with your refund notice. If interest was paid, the state will typically note whether it is taxable on the state return in the same document or form that reports the interest amount.
When state refunds generate interest
Not all state refunds include interest. Interest accrues only when the state holds your refund longer than the law allows. Most states are required to pay interest if they do not issue a refund within 30 to 45 days of the later of the return filing date or the date the return was actually filed. The exact timeline depends on your state.
Common reasons for delayed refunds include errors on the return, missing documentation, identity verification holds, or simply processing backlog. If your state processes your refund within the legal window, no interest is owed. If it takes longer, interest begins to accrue at a rate set by state law — typically between 0.5% and 1% per month, though this varies.
You do not have to request the interest; the state calculates and includes it automatically when the refund is issued. The refund check or direct deposit will show the principal amount and the interest separately, or the state will send a separate notice showing how much interest was paid.
Reporting interest on your federal return
If you received interest on a state refund, you must report it on your federal return even if your state does not tax it. The form you use depends on the total amount of interest you received from all sources that year.
If your total interest income (including refund interest, savings account interest, and any other interest) is $1,500 or less, you can report it directly on line 2b of Form 1040 without filing Schedule B. If it exceeds $1,500, you must file Schedule B and list each source of interest separately, including the state refund interest.
The state will send you a Form 1099-INT showing the interest amount. Keep this form with your tax records. If you do not receive one but know you were paid interest, contact the state tax authority and request a copy. The IRS will have received one, and you need to match what you report.
What happens if you do not report refund interest
The IRS receives a copy of every 1099-INT issued by a state. If you do not report the interest on your federal return, the IRS will eventually notice the mismatch and send you a notice asking for an explanation or payment of the tax owed on that interest plus any penalties and interest.
The tax owed on refund interest is usually small — if you received $50 in interest and you are in the 22% tax bracket, you owe about $11 in federal tax. However, penalties and interest on unpaid tax can add up quickly. It is simpler to report it when you file.
If you made an honest mistake and did not report the interest, you can file an amended return (Form 1040-X) to correct it. The IRS is generally more lenient with taxpayers who file amended returns voluntarily than with those who wait for the IRS to catch the error.
Frequently Asked Questions
Do I have to report state refund interest if the amount is very small?
Yes. There is no minimum threshold for reporting interest income to the IRS. Even $1 in refund interest must be reported on your federal return. However, if your total interest from all sources is $1,500 or less, you can report it on line 2b of Form 1040 without filing Schedule B.
What if I received interest on a federal tax refund instead of a state refund?
Federal refund interest is also taxable federal income and is reported the same way. The IRS will send you a Form 1099-INT if you received interest on a delayed federal refund. Federal refund interest is not taxable on any state return.
Can I deduct the taxes I paid on refund interest?
No. Refund interest is treated as income, not as a tax payment. You cannot deduct it or use it to offset other income. You simply report it as interest income and pay tax on it at your ordinary rate.
If my state does not tax refund interest, do I still report it on my state return?
No. If your state does not tax refund interest, you do not report it on your state return. You report it only on your federal return. Check your state's tax instructions or contact the state tax authority to confirm whether your state taxes refund interest.
What if the state sent me interest but did not send a 1099-INT?
Contact the state tax authority and request a Form 1099-INT or equivalent. The state is required to issue one if interest was paid. If the state cannot locate a record of the interest payment, ask for written confirmation of the amount and date so you have documentation for your federal return.