A cash basis taxpayer took an itemized deduction of $5,500 for state income tax paid in 2012. His total itemized deductions in 2012 were $18,000. In 2013, he received a $900 refund of his 2012 state income tax.The taxpayer must include the $900 refund in his 2013 Federal gross income in accordance with the tax benefit rule.

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The tax benefit rule requires a taxpayer to include a refund of a prior year deduction in the year of the refund if the deduction provided a tax benefit in the prior year. Since the taxpayer deducted the $5,500 state income tax on his 2012 tax return and received a refund in 2013, he must include the $900 in his 2013 Federal gross income.

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