Rule: IRC Section 111 provides that 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 previously imposed (the tax benefit rule). Choice "B" is correct. Under the tax benefit rule, an itemized deduction recovered in a subsequent year is included in income in the year recovered. In this question, only $1,150 of the state income taxes was actually deducted as an itemized deduction last year. The recovery is thus limited in the amount actually deducted (and not to the entire amount of the state tax refund).
Choice "d" is incorrect. The amount deducted, not $0, is included in income in the current year.
Choice "c" is incorrect. The amount originally deducted, not necessarily the entire amount of the refund, is included in income in the current year.
Choice "a" is incorrect. The amount deducted is included in income in the current year. It is not necessary to amend the prior year's return.