Question

Exercise 5-26 (Algorithmic) (LO. 3)

Myrna and Geoffrey filed a joint tax return in 2017. Their AGI was $99,825, and itemized deductions were $15,600, which included $12,480 in state income tax. In 2018, they received a $7,488 refund of the state income taxes that they paid in 2017. The standard deduction for married filing jointly in 2017 was $12,700.

Under the tax benefit rule, $______of the state income tax refund is included in gross income in 2018.

Answer 1

Generally, if a taxpayer obtains a deduction for an item in one year and in a later year recovers all or a portion of the prior deduction, the recovery is included in gross income in the year received. However, the § 111 tax benefit rule provides that no income is recognized upon the recovery of a deduction, or the portion of a deduction, that did not yield a tax benefit in the year it was taken. For example, if a taxpayer had no tax liability in the year of the deduction (e.g., itemized deductions and personal exemptions exceeded adjusted gross income), the recovery would be partially or totally excluded from gross income in the year of the recovery. Because the standard deduction in 2017 was $12,700, the $12,480 of state income taxes the taxpayers paid in 2017 yielded a tax benefit of only $2,900 ($15,600 itemized deductions − $12,700 standard deduction) in 2017. Under the tax benefit rule, only $2,900 of the state income tax refund is included in gross income in 2018.