Question

How does the tax benefit rule apply in the following cases?a. In 2015, the Orange Furniture Store, an accrual method taxpayer, sold furniture on credit for $1,000 to Sammy. The cost of the furniture was $600. In 2016, Orange took a bad debt deduction for the $1,000. In 2017, Sammy inherited some money and paid Orange the $1,000 he owed. Orange was in the 35% marginal tax bracket in 2015, the 15% marginal tax bracket in 2016, and the 35% marginal tax bracket in 2017.Orange Furniture must include _________ in gross income as the recovery of a prior deduction cost ________.b. In 2016, Marvin, a cash basis taxpayer, took a $2,000 itemized deduction for state income taxes paid. This increased his itemized deductions to a total that was $800 more than the standard deduction. In 2017, Marvin received a $1,600 refund when he filed his 2016 state income tax return. Marvin was in the 15% marginal tax bracket in 2016, but was in the 35% marginal tax bracket in 2017. How much must Marvin include in his gross income for 2017?________$.c. In 2016, Barb, a cash basis taxpayer, was in an accident and incurred $8,000 in medical expenses, which she claimed as an itemized deduction for medical expenses. Because of the 10%-of-AGI reduction, the expense reduced her taxable income by only $3,000. In 2017, Barb successfully sued the person who caused the physical injury and collected $8,000 to reimburse her for the cost of her medical expenses. Barb was in the 15% marginal tax bracket in both 2016 and 2017. What amount, if any, will Barb include in her 2017 gross income?___________$

Answer 1

a. Orange Furniture must include $1,000 in gross income as the recovery of a prior deduction cost.

Since the 2016 bad debt deduction resulted in a tax benefit, the $1,000 recovery will be considered income. Orange's cost for this transaction = (35% 2015 tax rate - 12% 2016 tax rate) x $1,000 recovery = 23% x $1,000 = $230

b. How much must Marvin include in his gross income for 2017? $800

Marvin's net benefit from itemizing his taxes was $800, so that amount must be included as gross income due to the state's refund. Marvin will actually suffer a lose due to this transaction since during 2016, he was in the 15% tax bracket, while during 2017 his tax bracket is 35%. He saved 15% x $800 = $120 for 2016, but will have to pay 35% x $800 = $280 during 2017.

c. What amount, if any, will Barb include in her 2017 gross income? $3,000

Since Barb was able to recover the medical expenses, she must include in her gross income the tax benefit that she received for itemizing her deductions.