Question

Problem 5-55 (LO. 3)

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.

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) In 2015, Orange sale would contribute to tax on profit of 400 @ 35%. In 2016, Organge recognise the debt as bad debt and claimed deduction, saving 1000@15%. However, he recieved the debt and thus then will have to pay the tax on amount received (since the same was claimed as deduction last year) i.e. 1000@35%.

B) In 2016, 800 wasnot charged to tax due to claiming of itemized deduction, the amount when recovered shold be included in Gross Income of 2017 and should be charged @ 35%. (Note that only difference between itemized deduction and standard deduction will be chargable to tax in subsequesnt yeras, if recovered)

C) In 2017, Barb should include 3000 to her 2017 gross income, since it escaped thae tax in 2016 @ 15%. The recovery is limited to deduction clamied earlier.