If you did not itemize your deductions on your Federal tax return for the same year that the state or local tax refund applies to, do not report any of the refund as income.

If you received a refund of state or local income taxes this year that you took an itemized deduction for in an earlier year, you may have to include all or part of the refund as income on your tax return. The Form 1040 instructions for the state and local tax refund line provide you with a worksheet to calculate the amount of your refund that is taxable. There is a more detailed worksheet called Itemized Deduction Recoveries in Publication 525, Taxable and Nontaxable Income. Report your taxable State or Local Refunds on Form 1040 (PDF). You cannot use Form 1040A (PDF) or Form 1040EZ (PDF). Refer to Tax Topic 405, Refund of State and Local Taxes, and Publication 525, Taxable and Nontaxable Income, for further information.

References:

• Publication 525, Taxable and Nontaxable Income
• Tax Topic 405, Refund of State and Local Taxes
• Form 1040 Instructions

Source: www.irs.gov