ExpertHard1 markMultiple Choice
CPA · Question 24 · Area IV: Individual Taxation
In Year 1, a taxpayer itemized deductions and deducted $5,000 of state income taxes. The total itemized deductions exceeded the standard deduction by $200. In Year 2, the taxpayer received a $500 refund of the Year 1 state income taxes. How much of the refund is taxable in Year 2?
In Year 1, a taxpayer itemized deductions and deducted $5,000 of state income taxes. The total itemized deductions exceeded the standard deduction by $200. In Year 2, the taxpayer received a $500 refund of the Year 1 state income taxes. How much of the refund is taxable in Year 2?
Answer options:
A.
$500
B.
$200
C.
$0
D.
$300
How to approach this question
Tax Benefit Rule: A refund is taxable only to the extent the prior deduction actually reduced tax liability. If itemized deductions were only $200 better than standard, the benefit was only $200.
Full Answer
B.$200✓ Correct
B
Under the tax benefit rule (IRC §111), a refund of a prior deduction is included in income only to the extent the deduction reduced taxable income in the prior year. Since the itemized deductions only exceeded the standard deduction by $200, the tax benefit was limited to $200. Therefore, only $200 of the refund is taxable.
Common mistakes
Including the entire refund as income without checking how much the deduction actually benefited the taxpayer.
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