Lynnette is a single individual who receives a salary of $36,000. During 2018, she has $6,800 withheld for payment of her federal income taxes and $2,900 for her 2018 state income taxes. In 2019, she receives a $450 refund after filing her 2018 federal tax return and a $750 refund after filing her 2018 state tax return.
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I. If Lynnette has total itemized deductions of $\$ 6,000$ on her 2018 federal tax return, she must include the entire $\$ 750$ refund in her 2018 gross income.
II. If Lynnette uses the standard deduction in filing her 2018 federal income tax return, the $\$ 750$ refund is not taxable in 2019 .

Question

Quizplus · Accepted Answer

Statement II is correct because if Lynnette uses the standard deduction for her 2018 federal income tax return, then the state tax refund of $750 received in 2019 is not taxable. This is because the tax benefit rule states that a refund is only taxable to the extent that the deduction of that payment provided a tax benefit in the prior year. Since she did not itemize deductions (where the state tax could have been deducted), she received no tax benefit from paying the state tax, thus the refund is not taxable. Statement I is incorrect because the taxability of the state refund depends on whether the taxpayer itemized deductions and if the deduction provided a tax benefit, not on the requirement to include it in gross income automatically.

Lynnette Is a Single Individual Who Receives a Salary of $36,000