Question

Problem 5-55 (LO. 3) How does the tax benefit rule apply in the following cases? a. In 2018, the Orange Furniture Store, an accrual method sole proprietorship, sold furniture on credit for $1,000 to Sammy. The cost of the furniture was $600. In 2019, Orange took a bad debt deduction for the $1,000. In 2020, Sammy inherited some money and paid Orange the $1,000 he owed. Orange's owner was in the 35% marginal tax bracket in 2018, the 12% marginal tax bracket in 2019, and the 35% marginal tax bracket in 2020. Orange Furniture must include in gross income as the recovery of a prior deduction. The timing of the income and deductions cost Orange b. In 2019, Marvin, a cash basis taxpayer, took a $2,000 itemized deduction for state income taxes paid; the deduction was not limited by the SALT cap. This increased his itemized deductions to a total that was $800 more than the standard deduction. In 2020, Marvin received a $1,500 refund when he filed his 2019 state income tax return. Marvin was in the 12% marginal tax bracket in 2019 but was in the 35% marginal tax bracket in 2020. How much must Marvin include in his gross income for 2020? c. In 2019, Barb, a cash basis taxpayer, was in an accident and incurred $8,000 in medical expenses, which she claimed as an itemized deduction for medical expenses. Because of the 7.5%-of-AGI reduction, the expense reduced her taxable income by only $3,000. In 2020, Barb successfully sued the person who caused the physical Injury and collected $8,000 to reimburse her for the cost of her medical expenses. Barb was in the 22% marginal tax bracket in 2019 12% in 2020. What amount, if any, will Barb include in hand

Answer 1

Answer a.

Orange Furniture must include $1,000 in gross income as the recovery of a prior deduction. The timing of the income and deductions cost Orange $230.

Sale revenue (gross income) = $1000

timing of the income and deductions cost = (35%-12%)*1000 = $230

Answer b.

$800

the amount of $800 that increased the itemized deduction will be included in the gross income.

Answer c.

$3000

the amount of $3000 that reduced taxable income