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2-2 - 35 Tim has state income taxes of $4,500 withheld from...

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35. Tim has state income taxes of $4,500 withheld from his salary during 2008. On his 2008 federal income tax return, Tim properly deducts the $4,500 as state taxes paid. Upon filing his 2008 state income tax return, he determines that his actual state income tax for 2008 is only $3,900, and the state sends him a $600 refund. What are the tax consequences of the refund? Explain in terms of the concepts presented in the chapter. This is a classic example of the tax benefit rule that taxes any amount deducted in a previous year as income in the year of recovery to the extent that a tax benefit was received from the recovered amount. Because Tim took a deduction for the entire $4,500 withheld, any refund of the state taxes must be included in income in the year of the refund. In this case, the $600 refund is taxable in 2009. Note that the annual accounting period concept does not allow Tim to go back and amend his 2008 return for the refund, because the events of each tax year are deemed to stand apart from each other. In working this problem, you may want to note that if, under the administrative convenience concept, Tim had not itemized his deductions (i.e., he used the standard deduction in 2008) he would not have to claim the $600 refund as income in 2009 because he did not take an actual deduction for the state income taxes. In addition, if Tim's itemized deductions did not exceed his standard deduction by more than $600, then only the excess of Tim's actual deductions over the standard deduction would be income under the tax benefit rule. For example, if Tim's 2008 total itemized deductions were $5,650, then only $200 of the refund would be income. This is the excess of total deductions over the 2008 standard deduction for a single individual ($5,650 - $5,450). How would your answer change if Tim's actual state income tax is $4,900 and he has to pay $400 with his state return? Because Tim is a cash basis taxpayer, he must take deductions in the year in which the allowable expense is paid. In this case, the additional $400 in 2008 state tax is paid in 2009. Under the annual accounting period concept, Tim cannot go back and amend his 2008 state tax deduction for taxes paid in 2009. Tim must deduct the taxes in 2009, the year that he pays the taxes.
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36. Jamal Corporation is an accrual basis taxpayer. In 2008, Jamal writes off a $1,000 account receivable from a customer who has died. In 2009, the former customer's estate sends Jamal a check for $600. What are the tax effects of the receipt of the $600 in 2009? Explain. Because Jamal Corporation took a $1,000 bad debt deduction in 2008, the subsequent recovery of the $600 in 2009 will be included as income in 2009 under the tax benefit rule. This will give Jamal the correct income on the receivable over the tax periods involved. For example, assume that the receivable was generated in 2007. As an accrual basis taxpayer, Jamal would have included the $1,000 as income in 2007. In 2008, when it discovered that the customer had died and Jamal did not expect to collect the receivable, Jamal would deduct the $1,000, canceling out the income recognized in 2007. The $600 receipt
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