Suppose that Alice ordinarily makes $100,000 a year. Then, in Year 1, she wins the lottery and experiences a one-time windfall of $2.4 million, bringing her income for that (single) year up to $2.5 million. Suppose she lives in a state with a flat 5% income tax. Then between January 1st and April 15th of Year 2, she pays her federal income tax and also $125,000 in state income taxes for the huge windfall in Year 1. Her income goes back to the usual $100,000 in Year 2. Now when it comes time to pay taxes for Year 2, she can deduct the $125,000 in state taxes that she payed in Year 2, which is more than her entire income that year. Wouldn't that mean that she she runs a net operating loss for individuals in Year 2?
It seems funny that any one-time windfall that increases your income to about 20 times its usual level should almost automatically lead to a "net operating loss" the following year, simply because your income returns to normal. Am I misunderstanding Alice's tax situation?