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State and local refunds and the AMT.

The taxability of state and local refunds has been relatively straightforward in the past. Sec. 111 provides that state and local refunds are to be included in income if a prior benefit was obtained from deducting the tax. However, the tax treatment is less clear when the taxpayer is subject to the alternative minimum tax {AMT} in the year of deduction.

Regs. Sec. 1.11 l-lib)(2) provides that state and local refunds are excluded from income if the deduction taken in the prior year could be reduced by the amount of the refund without increasing the overall tax} the typical example is when a refund is received by a taxpayer who did not itemize deductions in the previous year.

Another situation in which these refunds might not be taxable arises when a taxpayer had to pay AMT in the previous year. However, there are two possible scenarios for tax refunds and AMT. Under one, the tax treatment of refunds is clear. Unfortunately, this is not true under the second scenario.

In the first situation, the taxpayer is subject to AMT in the year of deduction because of permanent di/ferences between regular taxable income and AMT income. In this situation, tax refunds received in the next year are clearly excluded from income.

In the second situation, AMT is caused by timing differences {such as depreciation adjustments}. Taxpayers receive a credit against future regular tax to the extent that AMT is caused by timing differences. It is not clear whether the taxpayers have received a tax benefit under Sec. 111 from their state and local deduction. See the example above.

It would appear from Scenario 2 that the taxpayer received a tax benefit from the state and local tax deduction, since the AMT credit available was greater with the deduction {$2,324} than without it ($774}. However, the methodology adopted by Regs. Sec. 1.111-1 (and reiterated fit the IRS publication on this subject} is to compute prior year tax with and without the deduction. If there is no current tax increase without the deduction, no benefit is received and the refund is not taxable.

Sec. III{c} provides that an increase in a carryover item is treated as a tax benefit, it is not clear if the AMT credit is a carryover item. Regs. Sec. 1.111 - 1 only mentions net operating losses and capital losses, however, it was issued before the AMT credit provisions were enacted. The IRS publication similarly only mentions net operating losses and capital losses.

The AMT credit has caused confusion to the treatment of state and local refunds. Some tax advisers may treat the refund as taxable because of Sec. 111(c}, while others may argue that Sec. Ill{c} is not intended to cover the AMT credit, supporting this proposition with the approach taken by the regulations. Taxpayers need further guidance on this issue to avoid disputes in the future.

From Philip 1. Baptiste, CPA, Cohen & Company, Lorain, Ohio
COPYRIGHT 1992 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:alternative minimum tax
Author:Baptiste, Philip J.
Publication:The Tax Adviser
Date:Aug 1, 1992
Previous Article:Taxation of corporate-owned life insurance policy proceeds payable to shareholders.
Next Article:Amortization of life estates and term interests.

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