A cash basis taxpayer took an itemized deduction of $5,500 for state income tax paid in 2011.His total itemized deductions in 2011 were $18,000.In 2012,he received a $900 refund of his 2011 state income tax.The taxpayer must include the $900 refund in his 2012 Federal gross income in accordance with the tax benefit rule.

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According to the tax benefit rule, if a taxpayer receives a refund of a tax deduction that provided a tax benefit in a previous year, the refund must be included as income in the year of receipt. Since the taxpayer received a $900 refund of state income tax paid in 2011, which was deducted on his 2011 tax return, he must include the refund in his 2012 gross income.

A Cash Basis Taxpayer Took an Itemized Deduction of $5,500