State income taxes, including franchise taxes measured by net income, are deductible as itemized deductions by individuals. State and local income taxes assessed against interest income that is exempt from federal income tax is also deductible. However, state and local income taxes on other exempt income are not deductible.
A taxpayer is able to deduct state and local income taxes that have been withheld from their salary. They can also deduct tax payments made on prior year income in the year they are actually withheld or paid.
Estimated Tax Payments
Any estimated state tax payments made for which are not required to be made are not tax deductible. For example, if a taxpayer made an estimated state income tax payment but the estimate of the state tax liability for the year shows that the taxpayer will receive a refund of the full amount of the estimated payment, then the taxpayer was not required to make the payment and will not be allowed to deduct it as an itemized deduction.
If a taxpayer receives a refund of state, local, or foreign income taxes, all or part of the refund may need to be included in income in the year received. The tax benefit rule requires the taxpayer to include a tax refund in gross income of the year received to the extent that a tax benefit resulted from the deduction of the item in the earlier year.
This includes refund resulting from taxes that were over-withheld, not determined correctly, or re-determined as a result of an amended return. A refund of state, local, or foreign taxes may not be used to reduce the amount of taxes paid during the year to lower the deduction. The taxes paid and the refund received must be reported separately.