State tax refund interest is taxable federal income, and you'll report it on your federal return even though it came from a state

Interest paid on a state tax refund is taxable income on your federal tax return. The IRS treats it as ordinary interest income, the same way it treats interest from a savings account or bond. Your state will send you a Form 1099-INT if the interest exceeds $10, but you report it to the federal government, not back to the state.

This catches people off guard because the refund itself—the money you overpaid—is not taxable. But the interest the state paid you for holding your money is. The distinction matters: you don't owe tax on getting your own money back, but you do owe tax on what the state paid you for the delay.

The amount of interest varies widely depending on how long your refund took and your state's interest rate. Some states pay no interest at all. Others pay rates that range from 0.5% to over 7% annually, depending on the year and the state's rules. A refund that took six months might generate $50 in interest; one that took two years might generate $200 or more.

Key Takeaways

  • Interest on state tax refunds is taxable federal income and must be reported on your Form 1040, even though it came from your state.
  • Your state will send you a Form 1099-INT if the interest is $10 or more, showing the exact amount you received.
  • The interest is reported on Schedule 1 (Form 1040) as ordinary interest income and is added to your federal taxable income.
  • You cannot deduct the interest as a loss or offset it against the refund itself—it is treated as separate income.
  • If you did not receive a 1099-INT but received interest, you still must report it; the form is not required for amounts under $10.

How the IRS sees state refund interest

The IRS classifies interest paid by a state on a tax refund as taxable interest income. This is covered under IRC Section 61, which defines gross income to include all income from whatever source derived, with few exceptions. Interest from a state is not one of those exceptions.

The logic is straightforward: you earned that interest. The state held your money longer than it should have, and it paid you for that. That payment is income to you in the year you received it. The fact that it came from a government entity does not change the tax treatment.

This is different from the refund of tax you overpaid. That refund is a return of your own money and is not taxable. But anything the state paid you beyond returning what you overpaid—the interest—is new income and is taxable.

When you'll receive the Form 1099-INT and what it shows

If your state paid you $10 or more in interest on your tax refund, the state will issue you a Form 1099-INT by January 31 of the following year. This form shows the interest amount in Box 1 (Interest income). You will receive a copy, and the state will send a copy to the IRS.

The form will show your name, address, and tax ID (usually your Social Security number), along with the state's identification number. It will list only the interest, not the refund amount itself. If you received interest from multiple states or from a state in multiple years, you may receive multiple 1099-INT forms.

If the interest was less than $10, you will not receive a form, but you still owe tax on it. You must report it on your return based on your own records or the state's written notice of the refund and interest.

Where to report state refund interest on your federal return

You report state tax refund interest on Schedule 1 (Form 1040), Part I, line 8, labeled "Interest." This is where you report all ordinary interest income—from savings accounts, bonds, CDs, and in this case, from your state.

If you received a 1099-INT, match the amount on the form to the amount you enter on Schedule 1. If you did not receive a form but received interest, enter the amount you can document from the state's refund notice or payment record.

The interest is added to your other income and taxed at your ordinary income tax rate. If you are in the 22% federal bracket, for example, $100 in interest will increase your federal tax by $22 (before any credits or other adjustments). Some states also tax this interest on their own returns, though most do not.

State-by-state differences in refund interest rates

Not all states pay interest on refunds, and those that do use different rates. Some states pay interest only if the refund is delayed beyond a certain number of days (often 45 or 60 days). Others pay interest on all refunds, regardless of timing.

States that do pay interest typically use a rate set by statute or adjusted annually. These rates have ranged from less than 1% to over 7% in recent years, depending on the state and the year. A few states tie their rate to the federal underpayment rate, which changes quarterly. Others use a fixed rate set in law.

If you are unsure whether your state paid interest on your refund, check the refund notice or payment record the state sent you. It will show the refund amount and any interest separately. You can also contact your state tax department directly.

What you cannot do with state refund interest

You cannot deduct state refund interest as a loss or offset it against the refund itself. The refund is not income, so there is nothing to offset. The interest is separate income, and it is taxable at your full ordinary rate.

You also cannot claim it as a deduction on Schedule A (itemized deductions) or anywhere else on your return. Interest income is income; it is not a deductible expense. The only way to reduce the tax on it is to reduce your overall taxable income through other deductions or credits, which would lower your tax rate on all income, including the interest.

If you believe the state calculated the interest incorrectly, you can contact the state tax department to request a correction. If the state agrees, it will issue you a corrected 1099-INT or a written statement explaining the adjustment. You would then file an amended federal return if needed.

Frequently Asked Questions

Do I have to report state refund interest if I did not get a 1099-INT?

Yes. If you received interest and it was less than $10, the state is not required to send a form, but you still owe tax on it. Report it based on the state's refund notice or payment record. The IRS expects all interest income to be reported, whether or not a form was issued.

Can I claim the interest as a deduction on my state return?

Most states do not tax interest paid by the state itself on refunds. Check your state's rules, but in most cases, you report the interest only on your federal return. A few states may have different rules, so contact your state tax department if you are unsure.

What if my refund took a very long time and the interest seems high?

The interest amount is determined by your state's law and the rate in effect during the period your refund was delayed. You cannot reduce it or dispute it based on the amount being "too high." If you believe the state made an error in calculating the interest or the delay was unreasonable, contact the state tax department to request a review.

Does the interest count toward my income for purposes of other benefits or credits?

Yes. State refund interest is included in your adjusted gross income (AGI) and counts toward income limits for various credits and benefits, such as the Earned Income Tax Credit, education credits, or health insurance subsidies. A small amount of interest usually will not affect these, but it is worth checking if you are close to an income threshold.

If I owe state taxes, can the state keep the interest instead of paying it to me?

That depends on your state's law. Some states allow refunds to be offset against other debts you owe the state, including back taxes. If your state does this, it may explore the interest to the offset as well. Check your state's refund notice or contact the state tax department to understand how offsets work in your state.