ExpertHard1 markMultiple Choice
CPA · Question 24 · Area IV: Individual Taxation
In Year 1, a taxpayer paid $4,000 in state income taxes and deducted them as an itemized deduction. The taxpayer's total itemized deductions exceeded the standard deduction by $1,000. In Year 2, the taxpayer received a $1,500 refund of the state income taxes paid in Year 1. How much of the refund is taxable in Year 2?
In Year 1, a taxpayer paid $4,000 in state income taxes and deducted them as an itemized deduction. The taxpayer's total itemized deductions exceeded the standard deduction by $1,000. In Year 2, the taxpayer received a $1,500 refund of the state income taxes paid in Year 1. How much of the refund is taxable in Year 2?
Answer options:
A.
$0
B.
$1,000
C.
$1,500
D.
$4,000
How to approach this question
Tax Benefit Rule: Refund is taxable only to the extent the deduction REDUCED tax in the prior year. Compare (Itemized - Standard) vs Refund Amount.
Full Answer
B.$1,000✓ Correct
Under the tax benefit rule, a refund of a prior year deduction is included in income only to the extent the deduction reduced taxable income in the prior year. Since itemized deductions exceeded the standard deduction by only $1,000, only $1,000 of the $4,000 deduction provided a benefit. Therefore, only $1,000 of the refund is taxable.
Common mistakes
Including the entire refund as income.
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