Ted, a cash basis taxpayer, received a $150,000 bonus in 2018 when he was in the 35% marginal tax bracket. In 2019, when Ted was in the 24% marginal tax bracket, it was discovered that the bonus was incorrectly computed, and Ted was required to refund $40,000 to his employer. As a result of the refund, Ted can reduce his 2019 tax liability by $14,000 (.35 × $40,000).

Question

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Since Ted is a cash basis taxpayer, the refund he paid back to his employer is deductible in the year it was paid, which is 2019. Therefore, his tax liability for 2019 can be reduced by $14,000, which is the amount of tax he paid on the bonus in 2018 (35% of $150,000).

Ted, a Cash Basis Taxpayer, Received a $150,000 Bonus in 2018