Tonya is a cash basis taxpayer.In 2011,she paid state income taxes of $6,000.In early 2012,she filed her 2011 state income tax return and received a $600 refund.

Question

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Since Tonya is a cash basis taxpayer, she can only deduct the state income taxes that she paid in the year in which she paid them. Therefore, she would have claimed the $6,000 as an itemized deduction on her 2011 Federal income tax return. However, since she received a $600 refund in 2012, it means that she overpaid her state income taxes in 2011. As a result, she must include the $600 refund as income on her 2012 Federal income tax return. Option A is incorrect because reducing her itemized deductions would not be necessary even if her itemized deductions exceeded the standard deduction by at least $600. Option C is also incorrect because Tonya can still use the itemized deductions on her 2011 return even if it resulted in a refund. Option D is incorrect because there is no discharge of indebtedness in this situation. Finally, option E is incorrect because option B is the correct answer.

Tonya Is a Cash Basis Taxpayer