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Application of Sec. 1341 in the AMT context.

It has long been an accepted principle of tax law that when a taxpayer receives income under a "claim of right" the income must be reported for tax purposes. (See North American Oil Consolidated Co., 286 US 417 (1932).1 Derived from the basic proposition that income taxes are determined under an annual accounting system, the claim of right doctrine dictates that amounts received under a claim of right (and without restriction) during a tax year are includable in income without regard to whether the amounts may have to be surrendered in a future tax year.

There is a second rule to this doctrine. If a taxpayer does have to surrender amounts recognized in a prior tax year under a claim of right, the year of recognition is not retroactively modified. Instead, the amount surrendered is allowed as a deduction in the year of repayment. (See Lewis, 340 US 590 (19511.)

The application of these two rules could have inequitable resuits in certain circumstances. For example, if a taxpayer surrenders income recognized in a prior period under a claim of right and is subject to a lower tax rate in the year of surrender than in the year of initial recognition, the resulting deduction does not make the taxpayer whole. To deal with these inequities, Congress enacted Sec. 1341.

Under Sec. 1341, alternative methods are used to determine a taxpayer's tax liability in the year of repayment. The taxpayer's liability is equal to the lesser of --the tax for the tax year computed with the deduction (Sec. 1341(a)(41); or --the tax for the tax year computed without the deduction, minus the decrease in tax for the prior tax year (or years) that would result solely from the exclusion of such item (or portion thereof) from gross income for such prior year (or years)(Sec. 1341(a)(511.

To qualify for Sec. 1341 treatment, three requirements must be met.

* An item must have been included in gross income for a prior tax year (or years) because it appeared that the taxpayer had an unrestricted right to such item (Sec. 1341(a)(11).

* A deduction must be allowable for the tax year because it was established after the close of such prior tax year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item (Sec. 1341(a)(21).

* The amount must exceed $3,000 (Sec. 1341(a)(31).

It is important to note that there are a number of other hurdles that must be met to apply Sec. 1341. Sec. 1341 generally does not apply to any deduction attributable to an item included in gross income in a prior tax year by reason of the sale or disposition of inventory or stock in trade (Sec. 1341(b)(21). This eliminates, for example, the use of the rule for sales returns and allowances.

When a corporation has recognized income under a claim of right in a year in which it was subject to the regular tax system (up to a 46% rate), and then receives a deduction for repayment of some or all of the previously recognized amount in a year in which it is subject to the alternative minimum tax (AMT) system, the kind of inequities Sec. 1341 was designed to address are present; a current deduction reduces tax liability by a smaller amount than the amount by which the prior inclusion increased tax liability.

This raises the issue of whether the benefits of Sec. 1341 are available in the context of an AMT taxpayer. There is no guidance under either Sec. 1341 or Sec. 55 specifically dealing with the application of Sec. 1341 to the AMT.

Nevertheless, it appears that Sec. 1341 should apply. Sec. 1341(a)(5)(A) states that the current year tax liability reduced as a result of a recalculation of the prior year liability is the "tax for the tax year." Sec. 55 imposes the AMT by providing that tax equal to the excess of tentative minimum tax for the tax year over the regular tax is imposed. Without limiting language, the statute should be interpreted to provide that all tax for the tax year is reduced, including the tax imposed by Sec. 55. Further, the flush language preceding Sec. 1341(a)(4) provides that it is "the tax imposed by this chapter [i.e., Chapter 1] for the taxable year" that is defined as the lesser of two amounts. The tax imposed by Chapter 1 includes the AMT.

The purpose of Sec. 1341 is to eliminate the inequity of recognizing income in a higher tax rate year, and receiving an offsetting deduction in a later lower tax rate year. To accomplish this, the detriment of inclusion is measured at the prior year(s) rates and a benefit of equal amount is provided. To limit the benefit such that it cannot offset AMT would thwart this intent.

Although there are arguments that Sec. 1341 should not apply in the AMT context, they are not persuasive in light of the statutory analysis and intent of Sec. 1341. One such argument could be that the AMT is a self-contained tax system, and contains no provision comparable to Sec. 1341. Nevertheless, the application of Sec. 1341 would not thwart the intent of the AMT system. A taxpayer has included the amount in taxable income in an earlier year, and is thus not receiving the benefit of a tax preference that allows it to escape taxation on economic income.

Another argument could be that, at least when the regular tax rate is the same for both the year of the income inclusion and the year of the deduction, the minimum tax credit will make a taxpayer whole. However, the taxpayer is not made whole due to, at a minimum, the time value of the delayed benefit of use of the credit. If the taxpayer is in the AMT system for the foreseeable future, credit utilization could be deferred indefinitely. In addition, to the extent that the regular tax rate is higher in the year of income recognition than in the year of the deduction, the credit can never make the taxpayer totally whole. From Joel Walters, CPA, Washington, D.C.
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Title Annotation:alternative minimum tax
Author:Walters, Joel
Publication:The Tax Adviser
Date:Jul 1, 1992
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