State and local refunds and the AMT.

• Author: Baptiste, Philip J.
• Position: Alternative minimum tax

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...