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What is the tax benefit rule and its significance?

Under the so-called “tax benefit rule”, a taxpayer need not include in his gross income (and therefore need not pay tax on it) amounts recovered for his loss if he did not receive a “tax benefit” for the loss in a prior year. Equivalently stated, taxpayers must include in income any amounts recovered if they received a tax benefit in a prior year for that loss.

For example, if a taxpayer recovers an expense or loss that he previously wrote off against the prior year’s income, then the recovered amount must be included in the current year’s gross income. A “tax benefit,” is interpreted broadly and includes any exclusion, deduction or credit which reduced federal income tax due in a prior year. A tax benefit also includes increases in unexpired carryover losses for which the taxpayer has not yet utilized. IRC 111(c).