What happens with inadvertant excessive estimated state taxs...

I'm not sure if the IRS will re-characterize your state tax paid. If you're making equal estimated payments of $11,250 each, maybe you can skip the Jan/15/2009 payment.

Anyway, back to the basics. The rule is that if you get a tax deduction from state tax deduction, then any refund the following year is taxable (on page 1 of form 1040). So you should get the full 50k deduction for your 2008 return, but an additional 20k of tax on your

2009 return. So be sure to make estimated payments in 2009 to cover this.

Jack:

instruction for Line 7 on Form 6251 excludes from AMTI refunds of tax overpayments that provided a tax benefit in a prior year when the regular tax was paid. As a consequence neither the income used for the overpayment nor the refund with be taxed directly. Based on IRS SOI data it appears that the instruction on Line 7 of Form 6251 caused a loss to the Treasury in excess on $500,000,000 in 2005. The instruction has been in place since 1988.

I addressed this illicit "windfall" at the "Closing the Tax Gap" symposium at Stanford University last Saturday (November 8). Present at this symposium was the National Taxpayer Advocate, Nina Olson and Assistant US Attorney, Tax Division, Nathan Hockman and a substantial number of leading tax law professors from across the country. No one tried to talk me down.

There is just a little problem with that instructionon Line 7 of Form

6251. It is not consistent with the section 56(b)(1)(D) of the Internal Revenue Code. Section 56(b)(1)(D) is necessary to exclude from AMTI refunds of tax overpayments that in some cases provided a tax benefit in the prior year when the AMT was paid as a result of the two-tier capital gains rate scheme. A tax overpayment can result in more of the capital gains (and qualified dividends) being taxed at the lower rate (0% for 2008) and fewer of the gains being taxed at the higher rate.(15% in 2008). Without section 56(b)(1)(D), both the income and the refund related to a tax overpayment that provided the limited long-term capital gains rate tax benefit would be taxed at the AMT rate if the AMT is paid in both years.

Here is a question that should help illuminate the problem with IRS?s current instruction Line 7 on Form 6251) related to section 56(b)(1) (D).

How would the instruction for line 7 on Form 6251 (2007) change if section 56(b)(1)(D) of the Internal Revenue Code was amended to read as follows?

(D) Treatment of certain recoveries No recovery of any tax to which paragraphs (1), (2), or (3) of section

164(a) applied shall be included in gross income for purposes of determining alternative minimum taxable income. Subparagraph (D) shall not apply to the recovery of a tax allowable in computing adjusted gross income.

Here are the relevant parts of section 56(b)(1)(D) of the Internal Revenue Code as currently written.

Sec. 56. Adjustments in computing alternative minimum taxable income

b) Adjustments applicable to individuals

In determining the amount of the alternative minimum taxable income of any taxpayer (other than a corporation), the following treatment shall apply (in lieu of the treatment applicable for purposes of computing the regular tax): (1) Limitation on deductions (A) In general No deduction shall be allowed - (ii) for any taxes described in paragraph (1), (2), or (3) of section 164(a). Clause (ii) shall not apply to any amount allowable in computing adjusted gross income.

(D) Treatment of certain recoveries No recovery of any tax to which subparagraph (A)(ii) applied shall be included in gross income for purposes of determining alternative minimum taxable income.

If Congress also intended for the refund of a tax overpayment that provided a "full" tax benefit when the regular tax was paid to be excluded from AMTI then it seems to me that only the ?amended? version of section 56(b)(1) would produce those results. But Congress preserved the ?tax benefit rule? by limiting the exclusion on Line 7 of Form 6251 to refunds of tax overpayments to which subparagraph (A) (ii) applied, i.e., in years the AMT was paid. Thus a limited long- term capital gains rate based tax t benefit that was provided by a tax overpayment in the year that the AMT was paid could be offset by inclusion of the refund in the determination of the capital gains portion of the AMT in the refund year.

A letter that IRS wrote to me in 1996 concerning the exclusion of "all" tax refunds from AMTI was published in Tax Analysts in 1999. Since the two-tier capital gains rate scheme was not part of the IRC until 1997, it was not addressed in the letter. The two- tier captal gains rate scheme and the limited long-term capital gains rate based tax benefit that can result from it utterly destroyed the argument set forth by the attorney in the IRS Office of Chief Counsel in attempting to justify the "windfall".

It should be noted that if there is a limited long-term capital gains rate based tax benefit from a tax overpayment in a year the AMT is paid and the taxpayer pays the regular tax in the refund year the income/refund related to the tax ovepayment will be DOUBLE TAXED". That instruction violates section 111(a) of the Internal Revenue Code.

IRS instruction require that you include all taxes paid/ withheld in the year as deductions. See Form 1040 Instructions for Schedule A. To comply with the IRC, you will need to put a zero on Line 7 of Form

6251 for 2009 (aasuming the Form has not be corrected or modified.)

Cheers,

WDK

Too late to not make the final payment; I paid the entire sum in the first payment. I know there was no reason to do that, but that way I can't forget.

I made the assumption (possibly incorrect) that if state income tax isn't deductable under AMT, then a state tax refund wouldn't be taxable. No?

This is correct. To rephrase, if you were in AMT in 2008 then you didn't get a benefit from the state income tax deduction, so then the following year the state income tax refund is not taxable. There's a worksheet in the instructions for 1040 about how to calculate the taxable part of the refund (maybe part of it is taxable). I'm thinking if you're in the 33% tax bracket, then the state income tax deduction might give you a break of 33%, but AMT adds 28%, so the benefit is then really 5% -- but I'm not sure if it works that way. I've not yet tried to do that worksheet yet.

Point 1: That is correct but ff a state income tax overpayment caused you to transition from paying the regular tax to paying the AMT, then a portion of the refund would be taxable. The portion of the refund that would be taxable is the portion of the overpayment that reduced the regular tax to the point that it equaled the AMT.

Point 2: If a state income tax overpayment, for example, causes more of a taxpayer's capital gains to taxed at the lower long-term capital gains rate and fewer of the gains to be taxed at the higher rate then there can be a tax benefit. See page 2 of Form 6251. See instructions in IRS Publication 525 to determine if there was a benefit. You will have to figure out the portion of the overpayment that produced the benefit. As I indicated above, if you are similarly situated in the refund year, i.e. paying the AMT with regular taxable income excluding capital gains below the 25% tax rate threshold then IRS instructions will "more or less" work out to produce a "zero sum game". However, if you pay the regular tax in the refund year, IRS instructions will have you paying the regular tax on the refund ov the overpayment that produced the limited long-term capital gains rate tax benefit after paying the AMT on the income used for the overpayment. This of course violates section 111(a) of the IRC.

Cheers,

WDK

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