tax benefit rule

tax benefit rule

A rule that if one receives a tax benefit from an item in a prior year because of a deduction, such as for an uninsured casualty loss or a bad debt write-off, and then recovers the money in a subsequent year,the money must be counted as income in the subsequent year.

Example: Acme Inc. suffers a fire a few days after completion of a building that cost $500,000 to build. The building is a total loss. Acme's insurance company refuses to pay the claim, suspecting arson. Acme writes off the $500,000 loss as an expense on its taxes and sues the insurance company. Five years later Acme wins the lawsuit and receives an award of $500,000. The money must be reported as income because it was expensed in the earlier year. If it had never been written off, it would not be income when the judgment was recovered.

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Tax Benefit Rule

A rule that provides that the amount of an expense recovered must be included in income in the year of the recovery to the extent the original expense resulted in a tax benefit. The most common example is a state income tax refund of tax deducted in the prior year.