If a person receives a tax refund due to an overpayment, what is the correct treatment of the refund?

The correct treatment of a tax refund due to an overpayment is that it is not included as taxable income. This aligns with the tax principle known as the "tax benefit rule." Essentially, if a taxpayer received a tax benefit from the deduction that led to the overpayment, the refund relates to a prior year's expense that originally reduced taxable income.

When a taxpayer overpays their taxes and subsequently receives a refund, this refund is typically not taxable in the year it is received, provided the taxpayer did not receive a tax benefit from the payment that resulted in their refund. In other words, if the taxpayer claimed a deduction for state taxes paid and received a refund, only the portion of the refund that provided a tax benefit would be taxable. Otherwise, the refund itself does not constitute income in the year it is received, as it simply restores the taxpayer to their original financial position.

In summary, by understanding how tax refunds work under the tax benefit rule, it becomes clear why a tax refund due to an overpayment is generally not considered taxable income.