[k1zuna]

Robbe, a cash basis single taxpayer, reported $50,000 of adjusted gross income last year and

claimed itemized deductions of $5,500, consisting solely of $5,500 of state income taxes paid last

year. Robbe’s itemized deduction amount, which exceeded the standard deduction available to

single taxpayers for last year by $1,150, was fully deductible and it was not subject to any

limitations or phase-outs. In the current year, Robbe received a $1,500 state tax refund relating to

the prior year.What is the proper treatment of the state tax refund?

a. Include $1,500 in income in the current year.

b. Amend the prior-year’s return and reduce the claimed itemized deductions for that year.

c. Include none of the refund in income in the current year.

d. Include $1,150 in income in the current year.

Explanation

Rule: IRC Section 111 provides that gross income does not include income attributable to the

recovery during the taxable year of any amount deducted in any prior taxable year to the extent

such amount did not reduce the amount of tax previously imposed (the tax benefit rule).

Choice “d” is correct. Under the tax benefit rule, an itemized deduction recovered in a subsequent

year is included in income in the year recovered. In this question, only $1,150 of the state income

taxes was actually deducted as an itemized deduction last year. The recovery is thus limited in the

amount actually deducted (and not to the entire amount of the state tax refund).

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Can anyone explain this to me? I thought as long as you itemized last year, your state tax refund received this year is taxable?

FAR - Passed
AUD - Passed
BEC - Passed
REG - 8/22/2013

[SeattleAccountant]

It is taxable only up to the amount of actual benefit produced on the last year's tax return. Thus, out of $1,500 claimed, this taxpayer reduced his taxes last year (benefited) only by $1,150 and that is the amount that will be taxable, not the entire or received amount of $1,500.

This follows “tax benefit rule” by the IRS. See snip below from Publication 17.

“Recoveries: A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). You also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.

Tax benefit rule: You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year. For more information, see Publication 525.”

https://www.irs.gov/publications/p17/ch12.html

Becker Class of Jan - Aug 2013: FARB DONE!!!!
CPA license pending 🙂

[sonygal57]

Your prior year state refund MAY BE taxable on the current year tax return if you itemized your deductions.

A portion or all of the refund is taxable in the following situations:

The amount of the refund that is taxable is limited to the amount your Itemized deductions exceed your standard deduction.

The amount of the refund that is taxable is limited to the amount that the state income tax deduction exceeds the general sales tax deduction.

A refund is not taxable in the following situation:

Taxpayer took the standard deduction.

Taxpayer took the general sales tax deduction.

Good old Gandalf, "All we have to do is decide what to do with the time that is give to us."
"Not all those who wander are lost."

FAR: I slayed the Dragon!
BEC: I defeated the Siren!
AUD: I eliminated Medusa!
REG: ?????

[Author]

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