 Hello and welcome to the session in which we will discuss the tax benefit rule or the tax benefit doctrine. Why do we have to learn about this tax benefit rule? Well, we need to find out whether your state and local refund are taxable. When do you receive a refund? So let's assume you filed your taxes in year one and year one and as a result of this taxes you have a refund and you did not get your refund until year two. So in year two you received the refund and let's assume this refund is $3,000. The question is this, do you include the refund in your year two taxes? Because this was for year one, you overpaid your taxes and now you received a refund. Is it taxable? Well it all depends, what does it depend on? It depends on whether you itemized, you took a deduction for this amount. If you took a deduction for this amount in year one when you filed your taxes and you received it later, you received the refund, well guess what? Now you have to include this amount in your taxes and specifically it goes on schedule one which is where you list your other incomes. For example, you would list the $3,000 here and you would add up all your income, other income, let's assume they add up to be $10,000, then this $10,000 would go under other income, schedule one on your form 1040. Before we proceed any further, I have a public announcement about my company farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. So when do you have to include this? Assuming in year one, so on the prior year what happened in the prior year, you itemized your deduction and as a result, your total itemized deductions were for the sake of illustration $15,000. Now what you did when you went to file your taxes for year one, when you filed your taxes for year one, you had to choose between your standard deduction, which happens to be for a single individual $12,550, and your itemized deduction. You will choose the larger of the two. Well if you happen to choose $15,000, it means that your tax refund you benefited from your tax refund. Well if you benefited from your tax refund in year one and now we are in year two and you receive that money because you overpaid your taxes, then guess what? That money is taxable because you took advantage of it. However, if you used the standard deduction, simply put, you did not itemized, you used the standard deduction, then the refund because you did not take a tax, you did not use it to get a tax advantage, then it's not taxable. It's only taxable if you itemized and you got benefit and the taxable amount is to the degree of the benefit, which will work an example in a moment. So the refunds are not taxable if the payer did not itemize, period. And the prior year you did not itemize, therefore you did not deduct state and local taxes. Therefore if you receive a refund, it's not taxable. Why? Because state and local income taxes are example of itemized deduction. So if you don't itemize, you don't have to worry about them. When you itemize for a given year, for a given year and receive a tax benefit through the deduction, then future refunds are included in the taxpayer gross income of the year in which the refund is received. So if you took a deduction and you took advantage of the deduction, you get a tax benefit, then you get the refund later, then you have to include that refund in your taxes. And the same concept applies to your medical deduction, same concept because medical deductions are also on schedule A. So if you took, if you itemized and you took a medical deduction and you end up itemizing, then the insurance company refunded you that money, then guess what, you have to include that money as an income because you took advantage of the itemized deduction, same exact concept. The payer of the tax refund should share with the taxpayer for 1099G. So when you do receive a refund, you would always receive a 1099G, whether it's a state or local government. They will send it to you just a 1099G form and they will tell you this is the amount of the refund. Now, it doesn't have to be included unless you itemized and you benefited from their itemization. Obviously you would. It's worth noting that the amount of tax refund that should be included is limited to the access of the itemized deduction taken over the standard deduction available to the taxpayer based on their, his or her filing status. The best way to illustrate this is to take a look at an example. Let's take a look at this example. In year one, Josh itemized his deduction claiming 8700 of state and income taxes, 1,920 of charitable contribution and 4,300 of investment interest. And we'll talk about itemized deduction later on in a separate session. As a result, the total itemized deduction were 14,920. And Josh took his itemized deduction. In year two, the state refunded Josh $3,000. And remember, this $3,000 was already deducted part of their state and income tax deduction. Determine the amount, if any, that's taxable in year three. Now, because we received the money in year two, now we're filing in year three, do we have to give anything? Well, given that Josh took a deduction in year one, well, then Josh has to include the refund received in year two in his gross income to the extent that his total year one itemized deduction exceeds his year one standard deduction. Well, let's assume his standard deduction were $14,000. So if he took the standard deduction, he would have include, he would have took a deduction of $14,000. Since he itemized, well, his itemized deduction totaled $14,920. So the question is, how much of the $3,000 is included in his income when he filed his taxes? Well, guess what? He only benefited an extra, the extra was $920, $920. Because if he did not itemize, the government would give them a deduction of, would give a deduction of $14,000. Since he itemized, he got a benefit of $920. Therefore, although he received a refund of $3,000, only $920 is included in taxes because although he deducted a lot, he deducted $8,700, he received a refund of $3,000. The only amount that's taxable is the excess for the benefit. If his benefit was were higher, then let's assume, let's for the sake of changing the example, assuming his itemized deductions were $18,000, then he benefited the full $3,000. Therefore, the full $3,000 will be taxable. But since he only benefited for $920, only $920 is the taxable amount. What should you do now? Go to Farhat Lectures, whether you are a CPA candidate or an enrolled agent, look at additional resources, multiple choice through false exercises. That's gonna help you understand tax concepts much better. Study, the exam is worth it, the CPA exam, the enrolled agent is worth it. If you're an accounting student, invest in your career, invest in yourself. Good luck, study hard, and of course, stay safe.