Question

Mikey and Sal, married taxpayers filing a joint return, paid state income tax of $12,000 and other itemized deductions of $15,000 in 2020. Because the total of their allowable itemized deductions exceeded the standard deduction, they elected to itemize deductions on their 2020 federal income tax return rather than to claim the standard deduction. In May 2021, Mikey and Sal receive a refund of $1,000 for overpaid state income taxes paid in 2020. Under the tax benefit rule, how much of the $1,000 refund must they include in their gross income for 2021?

		$400
		$800
		$1,000
		$0
		$200

Answer 1

IRS provides for the standard deduction for married couple filing tax return for 2020 to $24,800. In the itemized deduction, assess claims entire deduction including state taxes paid.

In IRC, generally all income is subject to income tax except specifically excluded including recovery during the taxable year of any amount deducted in any prior taxable year. However, if the amount recovered did not reduce tax in earlier year when the deduction was claimed, such recovered amount is excluded from taxable income in the year of recovery. If the prior year’s deduction produced a partial tax benefit, then only the portion to the extent tax benefit was provided is includable in income in the year of recovery.

In the given case, the refund of $1,000 was claimed as itemized deduction which led to increase in deduction from $26,000 to $27,000. Hence, this $1,000 gave rise to tax benefit to Mikey and Sal in Previous year 2020. Hence, this entire refund of $1,000 shall be taxable in 2021 when refund is received by them.

Hence, option C, $1,000 is correct.