Tax-Benefit Rule Law and Legal Definition

Tax benefit rule is a judicially created doctrine seeking to repair some of the inflexibility inherent in the annual accounting system. According to this rule, if any loss or expense deducted in the previous year is recovered by the tax payer, the recovery must be included in the current year's gross income to the extent that it was previously deducted. The tax benefit rule ensures that if a taxpayer takes a deduction attributable to a specific event, and the amount is recovered in a subsequent year, income tax consequences of the later event depend in some degree on the prior related tax treatment.

The tax benefit rule is codified in 26 U.S.C. § 111(a). It provides: "Gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter."

Application of the tax benefit rule does not require "recovery" of funds in a later year. All that is necessary is that the later event is fundamentally inconsistent with the premise on which the deduction was initially based. [Hornberger v. Commissioner, 4 Fed. Appx. 174 (4th Cir. 2001)]