Question

Lizzie is a cash basis taxpayer. In 2016, she paid state income taxes of $5,000. In early 2017, she filed her 2016 state income tax return and received a $500 refund. Which of the following statements is true?

A) Lizzie must include the $5,000 as income in 2016.
B) Lizzie must include the $500 refund as income in 2017.
C) Lizzie does not need to include either the $5,000 payment or the $500 refund in her income.
D) Lizzie must include both the $5,000 payment and the $500 refund in her 2016 income.

Answer 1

The correct statement is that Lizzie must include the $500 refund as income in 2017, in accordance with the tax benefit rule, which applies since she's a cash-based taxpayer.

Step-by-step explanation:

Lizzie is a cash-based taxpayer who paid state income taxes of $5,000 in 2016 and received a $500 refund in 2017. The correct statement regarding this scenario is: that Lizzie must include the $500 refund as income in 2017. This is because, under the tax benefit rule, refunds received in a later year for taxes that were deducted in a previous year must be included in income to the extent that the taxpayer received a tax benefit from the deduction. In the case of Lizzie, because she is a cash-based taxpayer, the payment in the previous year would have been deducted from her income, lowering her taxable income, thus the refund is considered income.