State tax deducation & AMT

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whadyaknow
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State tax deducation & AMT

Post by whadyaknow »

I used TurboTax - TaxCaster over the weekend and found that I'll be hit by AMT this year. I also realized that I've under-withheld my state taxes (CA) for the year. Based on my limited reading, it looks like I should pay the CA estimated taxes next year, since I won't be able to deduct anything additional on my Federal returns this year. Does that sound right? One thing to note that I will probably not hit AMT next year.

Thanks in advance for your advice.
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kaneohe
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Re: State tax deducation & AMT

Post by kaneohe »

sounds right to me.......and if you pay the deficit early in January there shouldn't be much difference in any penalty.
btw...........you might want to check the AMT calculation with the HR Block calculator http://www.hrblock.com/get-answers/tax-calculators.html

For some reason when I was comparing Taxcaster and HR Block, they agree in 5 out of 6 cases but differed in 1 in an AMT situation. Never figured out why.
JohnF
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Re: State tax deducation & AMT

Post by JohnF »

On a somewhat related subject, I recently noticed that TaxCaster makes the standard/itemized deduction selection solely on the higher of the two. However, unless I’m missing something, when subject to AMT a smaller itemized may result in lower tax.
randomguy
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Re: State tax deducation & AMT

Post by randomguy »

JohnF wrote:On a somewhat related subject, I recently noticed that TaxCaster makes the standard/itemized deduction selection solely on the higher of the two. However, unless I’m missing something, when subject to AMT a smaller itemized may result in lower tax.

I don't think this is right. You might pay less AMT with a smaller itemized deduction but you will pay more normal tax so you end up paying the same or more when you lower your deductions. When you are in the same category, you are basically getting no benefit from the deduction and it makes sense to try and shift it around to a place where you can use it. Depending on your flexibility, it might make sense to move charitable giving forward (give for both 2014+2015) and while trying to shift tax payments (estimated taxes, real estate) out to 2015.
my2014
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Re: State tax deducation & AMT

Post by my2014 »

whadyaknow wrote:Based on my limited reading, it looks like I should pay the CA estimated taxes next year, since I won't be able to deduct anything additional on my Federal returns this year. Does that sound right?
All things equal that sounds right. Tax (state and real estate) exemptions are one of the most significant impacts to AMT. Deferring them into a none AMT year will give you a benefit next year.
JohnF
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Re: State tax deducation & AMT

Post by JohnF »

randomguy wrote:
JohnF wrote:On a somewhat related subject, I recently noticed that TaxCaster makes the standard/itemized deduction selection solely on the higher of the two. However, unless I’m missing something, when subject to AMT a smaller itemized may result in lower tax.

I don't think this is right. You might pay less AMT with a smaller itemized deduction but you will pay more normal tax so you end up paying the same or more when you lower your deductions. When you are in the same category, you are basically getting no benefit from the deduction and it makes sense to try and shift it around to a place where you can use it. Depending on your flexibility, it might make sense to move charitable giving forward (give for both 2014+2015) and while trying to shift tax payments (estimated taxes, real estate) out to 2015.
If not correct there’s a bug in TaxCaster. When I enter the wife’s and my ages as 64 (we’re over 65) the standard deduction is lower ($2,400) causing the program to use our itemized deduction. This yields a lower total tax with the difference being charitable contribution times tax rate.
randomguy
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Re: State tax deducation & AMT

Post by randomguy »

JohnF wrote:
randomguy wrote:
JohnF wrote:On a somewhat related subject, I recently noticed that TaxCaster makes the standard/itemized deduction selection solely on the higher of the two. However, unless I’m missing something, when subject to AMT a smaller itemized may result in lower tax.

I don't think this is right. You might pay less AMT with a smaller itemized deduction but you will pay more normal tax so you end up paying the same or more when you lower your deductions. When you are in the same category, you are basically getting no benefit from the deduction and it makes sense to try and shift it around to a place where you can use it. Depending on your flexibility, it might make sense to move charitable giving forward (give for both 2014+2015) and while trying to shift tax payments (estimated taxes, real estate) out to 2015.
If not correct there’s a bug in TaxCaster. When I enter the wife’s and my ages as 64 (we’re over 65) the standard deduction is lower ($2,400) causing the program to use our itemized deduction. This yields a lower total tax with the difference being charitable contribution times tax rate.
I definitely could be wrong, but it really doesn't sound right. Your AMT tax amount (total tax owed) does not change with picking between the standard deduction and itemized (those numbers are not used) so I don't see how if you were paying AMT originally you would not be paying it now.
Sagenick48
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Re: State tax deducation & AMT

Post by Sagenick48 »

AMT is really complicated. As I remember looking at it, when you take the standard deduction, the way AMT is calculated you are placed at a disadvantage. I don't remember the exact details but it is like you get no deduction at all. That has to do with the way AMT works.

Then to take another example, one year I actually reduced my taxes by electing to take the sales tax deduction versus the income tax deduction. I saved something like $500 by reducing my deductions by over $20,000. Isn't the tax code wonderful, by that I mean full of wonder!

My point is that when you are in AMT nothing makes sense. All you can do is run the alternatives and pick the best one. And if you are like me, since you don't know your income to the $ until mid March, when the last of the k-1's arrive, there is not a lot you can do.
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grabiner
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Re: State tax deducation & AMT

Post by grabiner »

Part of the issue is that the terminology is confusing. There are two tax rules, with different tax rates and deductions: the regular rules, and the AMT rules. You compute your tax under the AMT rules to find your Tentative Minimum Tax (TMT). If the TMT is less than the regular tax, you pay the regular tax. If the TMT is more than the regular tax, the amount you pay is equal to the TMT, but it is consider to be a payment of all of your regular tax, and then the difference is the AMT. (This matters for several purposes, such as eligibility to claim an AMT credit for other years.)

Thus, if you might or might not owe AMT, you have to look at potential tax moves according to both sets of tax rules; a tax move which increases your regular tax but decreases your AMT may be good or bad, depending on which tax you end up paying.
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Re: State tax deducation & AMT

Post by Two Headed Mule »

As grabiner said, part of the issue is terminological. In general, it will almost always make sense to itemize when itemized deductions exceed the standard deduction (since you save regular tax and are at least no worse off under amt, which doesn't allow a standard deduction). If the standard deduction exceeds your itemized amount, you'll need to run the numbers.

Itemized deductions exceed standard: Suppose the standard deduction is $10,000 and you have $20,000 of itemized deductions, comprised of $9,000 of mortgage interest and $11,000 of property tax/state income tax. In this case, there is no point taking the standard deduction. Itemizing results in an additional $10,000 deduction for regular tax purposes and an additional $9,000 deduction for amt purposes (mortgage interest) vs taking the standard deduction. This is probably the most common situation.

Standard exceeds itemized: Suppose you have only $9,000 of itemized deductions, comprised entirely of charitabe contributions (or mortgage interest) and the standard deduction is $10,000. Itemizing in this case will result in a net loss of a $1,000 deduction for regular income tax, but will result in an additional deduction of $9,000 for amt since the mortgage interest is deductible for amt. If you owe significant amt (meaning that the tax calculated under amt rules exceeds that calculated under regular rules), the regular tax increase caused by the lost $1,000 deduction is meaningless and you should itemize even though it is less than the standard deduction. This type of situation is (much) less common, but possible. If you are in this sitution because you exercised incentive stock options, the benefit to itemizing is less because you will get a tax credit for any additional amt amount owed, but you may not be able to use it for a while, resulting in a time value detriment.

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Sagenick48
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Re: State tax deducation & AMT

Post by Sagenick48 »

I think we are all making the same point if stated a bit differently. That is in my case based on some actual experience, that than spent studying the code and the forms.

I don't have mortgage interest deductions, but have charitable. So AMT recognizes charitable deductions but does not recognize state tax deductions. So for AMT calculations when you take the standard deduction it is like the standard deduction is treated all as a state tax deduction. Which is worthless. Actually less than worthless. I will explain later.

This is a problem when you attempt to use tax estimator programs. They blithely assume that you want the largest deduction. Try to get Turbo Tax to let you take the smaller of the standard versus itemized deduction. It will ask you several times If you are sure you want to do that.

In AMT taking the smaller deduction may reduce your tax, so you have to run sample returns which you can only do using last program, using last years tax rules, and actual returns, not taxcaster, since this years tax rules are only being finalized as I write the post.

It is worse if you get tax refunds. At least under TT, the way they calculate the tax benefit rule if you save $1 of tax because of a state tax deduction, you have to take any state tax refund into income the next year.

So, in year one, if you get overwithheld $2000 of income taxes, your tax rate on your marginal income is (in my state ) 48.65%. Effective Rate of AMT is 125% of marginal fed rate of 28% = 35% plus net investment income tax of 3.8% plus state rate, no fed deduction, of 9.85%. Your state tax deduction in AMT is zip because it is not allowed in AMT.

Then the next year since you got the $1 of value, caused as best I can tell by rounding error, you have to take the entire $2000 of refund into income paying again 48.65% in marginal rates.

This doesn't include the effect of the Pease phaseouts. Which could put you over a 100% marginal rate.

That is why I have gone to half time.
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MarkNYC
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Re: State tax deducation & AMT

Post by MarkNYC »

Sagenick48 wrote: It is worse if you get tax refunds. At least under TT, the way they calculate the tax benefit rule if you save $1 of tax because of a state tax deduction, you have to take any state tax refund into income the next year.

So, in year one, if you get overwithheld $2000 of income taxes, your tax rate on your marginal income is (in my state ) 48.65%. Effective Rate of AMT is 125% of marginal fed rate of 28% = 35% plus net investment income tax of 3.8% plus state rate, no fed deduction, of 9.85%. Your state tax deduction in AMT is zip because it is not allowed in AMT.

Then the next year since you got the $1 of value, caused as best I can tell by rounding error, you have to take the entire $2000 of refund into income paying again 48.65% in marginal rates.
What you describe is not a punitive aspect of tax law. It is simply a limitation (some might say "flaw") in computer tax programs, which incorrectly treat the full state tax refund as taxable if the refund amount, having been deducted in the prior year, produced ANY tax benefit. The law only requires that you include in income the portion of the refund that produced the benefit. This error is very easy to miss. In such situations, it often takes a bit of time and effort to figure the correct refund amount that is taxable, but sometimes the tax savings from getting it correct can be significant.
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Re: State tax deducation & AMT

Post by bsteiner »

MarkNYC wrote:
Sagenick48 wrote: It is worse if you get tax refunds. At least under TT, the way they calculate the tax benefit rule if you save $1 of tax because of a state tax deduction, you have to take any state tax refund into income the next year.

So, in year one, if you get overwithheld $2000 of income taxes, your tax rate on your marginal income is (in my state ) 48.65%. Effective Rate of AMT is 125% of marginal fed rate of 28% = 35% plus net investment income tax of 3.8% plus state rate, no fed deduction, of 9.85%. Your state tax deduction in AMT is zip because it is not allowed in AMT.

Then the next year since you got the $1 of value, caused as best I can tell by rounding error, you have to take the entire $2000 of refund into income paying again 48.65% in marginal rates.
What you describe is not a punitive aspect of tax law. It is simply a limitation (some might say "flaw") in computer tax programs, which incorrectly treat the full state tax refund as taxable if the refund amount, having been deducted in the prior year, produced ANY tax benefit. The law only requires that you include in income the portion of the refund that produced the benefit. This error is very easy to miss. In such situations, it often takes a bit of time and effort to figure the correct refund amount that is taxable, but sometimes the tax savings from getting it correct can be significant.
TaxCut (now H&R Block) gives you the opportunity to fill in the amount of the state income tax refund that's taxable. Of course, in those cases where some but not all of the state income tax deduction provided a benefit in the prior year, it can take some effort to determine the amount that provided a benefit in the prior year.
Sagenick48
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Re: State tax deducation & AMT

Post by Sagenick48 »

Ok guys, First, I respect your views, and appreciate the forum.

Second, my basic comment was, or should have been, that when you are in AMT, you need to run the numbers, and nothing about AMT makes sense, especially if you are used to dealing with the regular tax code.

That is what grabiner said, and grabiner is right on. You need to look at the alternatives and then pick the best one.

That isn’t always clear.

I am sure there is someone out there who has wrapped their head around AMT, but the best tax accountant I know told me he couldn’t.

So in response to MarkNYC, I am not saying, that our policy makers intended to make AMT punative, after all the number of them who actually do their own taxes can probably be counted on our eyes, ears, fingers and toes, so how can they have intended to do something they can’t understand, in the details, but the application of the rules in particular cases can be punative.

And I don’t believe it is a flaw in computer programs. I spent 5 or 6 hours looking at and working on this issue. It may be a flaw in the “tax code” but (see caveat below) I concluded the tax programs were working correctly.

As to bsteiner, I have a great deal of respect for your comments, I do estate planning also, but from my review of the TurboTax program, they are doing it consistent with IRS publications.
Let me start out with how the so called tax benefit rule works, and all the quotes are from Publication 525, beginning at page 22.
Tax benefit rule. You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any in-crease to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year.



State tax refund. If you received a state or local income tax refund (or credit or offset) in 2013, you generally must include it in income if you deducted the tax in an earlier year. ..
If you could choose to deduct for a tax year either:

State and local income taxes, or

State and local general sales taxes, then
the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you did not choose to deduct for that year.
Continuing
Itemized Deduction Recoveries

The following discussion explains how to determine the amount to include in your income from a recovery of an amount deducted in an earlier year as an itemized deduction. However, you generally do not need to use this discussion if you file Form 1040 and the recovery is for state or local income taxes paid in 2012. Instead, use the worksheet in the 2013 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income.
You cannot use the Form 1040 worksheet and must use this discussion if you are a non-resident alien (discussed later) or any of the following statements are true.



(7) You owed alternative minimum tax in 2012.
Continuing
Total recovery included in income. If you re-cover any itemized deduction that you claimed in an earlier year, you generally must include the full amount of the recovery in your income in the year you receive it. This rule applies if, for the earlier year, all of the following statements are true.
(6) You were not subject to alternative minimum tax. (If you were subject to alternative minimum tax, see Subject to alternative minimum tax, later.)

If any of the earlier statements is not true, see Total recovery not included in income, later.
Concluding
Subject to alternative minimum tax. If you were subject to the alternative minimum tax in the year of the deduction, you will have to re-compute your tax for the earlier year to determine if the recovery must be included in your in-come. This will require a recomputation of your regular tax, as shown in the preceding example, and a recomputation of your alternative minimum tax. If inclusion of the recovery does not change your total tax, you do not include the recovery in your income. However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year.
So the bottom line is this, if you get one dollar of tax reduction, and you are in AMT you have to include your refunded amount. The key words are “However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year.”

So, now let’s go to the real world. This is what happened to me.

In 2012 using Turbotax, and having been in AMT for something like the past 10 or more years, I took the state income tax deduction assuming that since I was in AMT it didn’t matter for future refund purposes. After all, state taxes are not deductible for AMT purposes.

When I put the numbers in the 2013 return, Turbotax led me through the complicated calculations including recalculating the 2012 return. TT said my state income tax refund was fully taxable. I checked the calculations (the worksheet in TT) and it said that I got a tax benefit from taking the deduction. I questioned what the calculations were so I went back to my 2012 return.

So, I redid my 2012 taxes without electing the state income tax deduction and instead elected the state sales tax deduction. I found that by doing that my tax went up by $1 dollar but because of another part of the AMT rules my tax payable went down by $44 because I was able to use $45 of foreign tax credit that was otherwise suspended.

I promptly filed an amended 2012 return electing the sales tax deduction. My state tax deductions were reduced by $25,032. Form 1040 Line40. My tax went up by $1. Line 46. My credits went up by $45. Line 47. So total tax went down by $44. Line 61. I got a $44 refund.

All the calculations were done by TT. The IRS accepted the amended return without question and issued the refund check promptly.

I then filed my 2013 return and said that I did not take a deduction for state income taxes and my state tax refund then was not taxable.

So, not taking a plus $25000 deduction increased my tax by $1. Probably it is a result of dollar rounding in the hundreds of calculations required to do taxes. But not taking the deduction decreased my payable tax by $44 and reduced my next year’s taxable income by the amount of my refund (second state) of almost $2000.

I still think there may be a glitch in the TT program in the way it runs the calculation. In simple words, if the deduction reduces your tax by more than zero, then tax benefit and refund taxable. That is correct as I understand it, the tax benefit rule for AMT is an all or nothing rule. Bsteiner, this is different from regular tax, see Pub 525. If zero, there is no tax benefit and refund not taxed. If less than zero, then I am not sure if the program correctly calculates it, but I am not sure if it is looking at line 46 or line 61,of the 1040, and I am not sure which line it should be looking at. In the end, I wasn't going to spend more time on it since I solved my problem by filing the amended return.

Conclusion, as grabinger said, you need to run the alternative returns and you need to run them thinking for more than one year.
Last edited by Sagenick48 on Sat Dec 20, 2014 6:24 am, edited 1 time in total.
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grabiner
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Re: State tax deducation & AMT

Post by grabiner »

Sagenick48 wrote:I still think there may be a glitch in the TT program in the way it runs the calculation. In simple words, if the deduction reduces your tax by more than zero, then tax benefit and refund taxable. That is correct as I understand it, the tax benefit rule for AMT is an all or nothing rule. Bsteiner, this is different from regular tax, see Pub 525.
No, it is not an all-or-nothing rule; see this text which you quoted.
IRS wrote:Subject to alternative minimum tax. If you were subject to the alternative minimum tax in the year of the deduction, you will have to re-compute your tax for the earlier year to determine if the recovery must be included in your income. This will require a recomputation of your regular tax, as shown in the preceding example, and a recomputation of your alternative minimum tax. If inclusion of the recovery does not change your total tax, you do not include the recovery in your income. However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year.
Thus, if you paid $25,000 in state tax, and $1000 of that deduction reduced your tax but the other $24,000 did not, then only $1000 of the refund is taxable in the next year.
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Sagenick48
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Re: State tax deducation & AMT

Post by Sagenick48 »

Grabiner, if you are correct, then Turbotax is wrong. That is all I can say. That is the way it calculates it. I have been there and done that calculation. I didn't misenter the information. It had the prior years return.

Reading it again, I can see what you are saying. If you had a $25000 tax deduction, and $2000 of that was a recovery, then you compare what your tax would be if you had a $25000 deduction versus a $23000 deduction. That works in the regular tax scheme.

And I apologize because this is all being done in shorthand. Actually, using round numbers, in my example the state tax deduction was $40,000. State income tax was $28,000. The eventual recovery amount was $2000.

But in AMT your state tax deductions are supposedly not deducted. So what is being recalculated?

Or as I explained when I recalculated my 2012 tax and reduced my state tax deductions by $25000 (state income tax of $28000 not deducted, state sales tax deducted, $3000) to a total state tax deduction of $15000 versus $40000, my tax went up $1.

So, the $2000 recovery amount produced a $1 tax benefit.

What I am saying is that if you receive any tax benefit from the extra $2000 deduction, you include the entire $2000 recovery in the next years income. So $1 of tax benefit equals a $2000 recovery included in income.

At least that is what the rule says to me and that is how turbotax appears to calculate it.
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Re: State tax deducation & AMT

Post by toast0 »

One additional oddity with AMT. The state income tax deduction actually can make a difference, in some cases. If you have a lot of long term capital gains, and not a lot of normal income, having enough state tax to cancel out all of the ordinary income will allow you to get some capital gains at 0% and some at 15% for AMT. This is because the 0% and 15% AMT capital gains amounts are computed using numbers from the qualified dividends and capital gain tax worksheet (line 44) for 0% capital gains tax in regular federal income, which allows the income tax deduction.

Example for 2013 (nice round numbers to make the point): 200k ordinary income, 4M LTCG, married joint filing, with 0 state tax, federal tax is about 839k. With a deduction for 317,000, federal tax is down to 819k.
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Re: State tax deducation & AMT

Post by kaneohe »

I can't say I understand in detail what you folks are talking about.................only that it sounds complicated if you get a state tax refund and that I might rather underpay and try to use the more uncertain 90% of current yr taxes safe harbor rather than the more certain 100% (or 110%) of last yrs taxes so I can avoid a state tax refund. I know there is a worksheet for the taxable part of state tax refunds for the normal tax and I think I understand the basic idea but would have some trouble doing the calculation on my own w/o the worksheet.

Is there an equivalent worksheet for the AMT case where one can grind it out step by step without thinking?..............I guess that's basically what software guys do .....implement some formula but to get it right, you really have to understand how stuff works.

This reminds me of the kawill table for determining whether Roth distributions are subject to tax/penalty. You can have 100 of us monkeys read the words describing how it works and it is likely that say 80% or more of us would get it wrong. His table reduces a million words to a simple flowchart like table so that 90% of us could get it right.

If someone could develop a similar thing for the AMT treatment of state tax refunds, it would be a significant contribution to the world.........take that as a subtle bribe to create a useful formula :happy or does such a thing already exist?
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Re: State tax deducation & AMT

Post by Two Headed Mule »

Sagenick48 wrote:But in AMT your state tax deductions are supposedly not deducted. So what is being recalculated?
You recalculate under the AMT and regular tax rules. Most commonly, a benefit occurs because decreasing the deduction for state income tax in the prior year will increase your regular tax enough to take you out of AMT. Suppose you calculate your tax as follows:

AMT rules: $50,000
Regular rules: $49,000

You pay the larger of the two -- $50,000 (technically, your AMT liability is $1,000 -- this is the terminological problem that's been referenced above). Now suppose that the next year you get a refund of $8,000 in state income tax. Did that $8,000 refund provide a tax benefit in the prior year?

As you point out, decreasing state income tax by $8,000 in the prior year will usually not change the result under the AMT rules ($50,000) since state income tax is an AMT preference item (and so was never deducted to begin with), but what about the regular tax calculation? Suppose you were in the 25% bracket (to keep the math simple) that year. Decreasing state income tax by $8,000 would increase the tax as calculated for regular purposes from $49,000 to $51,000. So taking the $8,000 deduction in the prior year saved you $1,000 in tax. But at a tax rate of 25%, only the last $4,000 of the deduction provided any tax benefit -- so only $4,000 should be included in income the next year.

Mule
MarkNYC
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Re: State tax deducation & AMT

Post by MarkNYC »

Sagenick48 wrote: ...as I explained when I recalculated my 2012 tax and reduced my state tax deductions by $25000 (state income tax of $28000 not deducted, state sales tax deducted, $3000) to a total state tax deduction of $15000 versus $40000, my tax went up $1.

So, the $2000 recovery amount produced a $1 tax benefit.

What I am saying is that if you receive any tax benefit from the extra $2000 deduction, you include the entire $2000 recovery in the next years income. So $1 of tax benefit equals a $2000 recovery included in income.

At least that is what the rule says to me and that is how turbotax appears to calculate it.
This is a different issue than "state tax deduction vs AMT." By amending the 2012 tax return to deduct sales tax rather than state income tax, any state income tax refund you receive in 2013 is not taxable because you did not take a deduction for any state income tax in the prior year.
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Re: State tax deducation & AMT

Post by randomguy »

Two Headed Mule wrote:
Sagenick48 wrote:But in AMT your state tax deductions are supposedly not deducted. So what is being recalculated?
You recalculate under the AMT and regular tax rules. Most commonly, a benefit occurs because decreasing the deduction for state income tax in the prior year will increase your regular tax enough to take you out of AMT. Suppose you calculate your tax as follows:

AMT rules: $50,000
Regular rules: $49,000

You pay the larger of the two -- $50,000 (technically, your AMT liability is $1,000 -- this is the terminological problem that's been referenced above). Now suppose that the next year you get a refund of $8,000 in state income tax. Did that $8,000 refund provide a tax benefit in the prior year?

As you point out, decreasing state income tax by $8,000 in the prior year will usually not change the result under the AMT rules ($50,000) since state income tax is an AMT preference item (and so was never deducted to begin with), but what about the regular tax calculation? Suppose you were in the 25% bracket (to keep the math simple) that year. Decreasing state income tax by $8,000 would increase the tax as calculated for regular purposes from $49,000 to $51,000. So taking the $8,000 deduction in the prior year saved you $1,000 in tax. But at a tax rate of 25%, only the last $4,000 of the deduction provided any tax benefit -- so only $4,000 should be included in income the next year.

Mule

Is that right? My understanding is that you would take all 8k as income when doing your taxes under then normal tax code. When you got to do AMT the tax refund would show up on line 7 of 6251 and be subtracted from your AGI. If you are always in AMT land this doesn't change much. If your alternating back and forth between normal and AMT land, I could see this being an issue. The solution is to stop giving your governments interest free loans:)
Two Headed Mule
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Re: State tax deducation & AMT

Post by Two Headed Mule »

randomguy wrote:
Two Headed Mule wrote:
Sagenick48 wrote:But in AMT your state tax deductions are supposedly not deducted. So what is being recalculated?
You recalculate under the AMT and regular tax rules. Most commonly, a benefit occurs because decreasing the deduction for state income tax in the prior year will increase your regular tax enough to take you out of AMT. Suppose you calculate your tax as follows:

AMT rules: $50,000
Regular rules: $49,000

You pay the larger of the two -- $50,000 (technically, your AMT liability is $1,000 -- this is the terminological problem that's been referenced above). Now suppose that the next year you get a refund of $8,000 in state income tax. Did that $8,000 refund provide a tax benefit in the prior year?

As you point out, decreasing state income tax by $8,000 in the prior year will usually not change the result under the AMT rules ($50,000) since state income tax is an AMT preference item (and so was never deducted to begin with), but what about the regular tax calculation? Suppose you were in the 25% bracket (to keep the math simple) that year. Decreasing state income tax by $8,000 would increase the tax as calculated for regular purposes from $49,000 to $51,000. So taking the $8,000 deduction in the prior year saved you $1,000 in tax. But at a tax rate of 25%, only the last $4,000 of the deduction provided any tax benefit -- so only $4,000 should be included in income the next year.

Mule

Is that right? My understanding is that you would take all 8k as income when doing your taxes under then normal tax code. When you got to do AMT the tax refund would show up on line 7 of 6251 and be subtracted from your AGI. If you are always in AMT land this doesn't change much. If your alternating back and forth between normal and AMT land, I could see this being an issue. The solution is to stop giving your governments interest free loans:)
Only the amount that provided a tax benefit shows up on line 10 of your 1040, not the full amount of the refund (so $4,000 in the admittedly crude example above). If there was no tax benefit at all, there is no inclusion. Whatever the amount is, it will always be backed out on line 7 of form 6251 because that amount gave no benefit under AMT in the prior year.

Mule
kaneohe
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Re: State tax deducation & AMT

Post by kaneohe »

Two Headed Mule wrote:
randomguy wrote:
Two Headed Mule wrote:
Sagenick48 wrote:But in AMT your state tax deductions are supposedly not deducted. So what is being recalculated?
You recalculate under the AMT and regular tax rules. Most commonly, a benefit occurs because decreasing the deduction for state income tax in the prior year will increase your regular tax enough to take you out of AMT. Suppose you calculate your tax as follows:

AMT rules: $50,000
Regular rules: $49,000

You pay the larger of the two -- $50,000 (technically, your AMT liability is $1,000 -- this is the terminological problem that's been referenced above). Now suppose that the next year you get a refund of $8,000 in state income tax. Did that $8,000 refund provide a tax benefit in the prior year?

As you point out, decreasing state income tax by $8,000 in the prior year will usually not change the result under the AMT rules ($50,000) since state income tax is an AMT preference item (and so was never deducted to begin with), but what about the regular tax calculation? Suppose you were in the 25% bracket (to keep the math simple) that year. Decreasing state income tax by $8,000 would increase the tax as calculated for regular purposes from $49,000 to $51,000. So taking the $8,000 deduction in the prior year saved you $1,000 in tax. But at a tax rate of 25%, only the last $4,000 of the deduction provided any tax benefit -- so only $4,000 should be included in income the next year.

Mule

Is that right? My understanding is that you would take all 8k as income when doing your taxes under then normal tax code. When you got to do AMT the tax refund would show up on line 7 of 6251 and be subtracted from your AGI. If you are always in AMT land this doesn't change much. If your alternating back and forth between normal and AMT land, I could see this being an issue. The solution is to stop giving your governments interest free loans:)
Only the amount that provided a tax benefit shows up on line 10 of your 1040, not the full amount of the refund (so $4,000 in the admittedly crude example above). If there was no tax benefit at all, there is no inclusion. Whatever the amount is, it will always be backed out on line 7 of form 6251 because that amount gave no benefit under AMT in the prior year.

Mule
I think I understand the part about line 10 of 1040................there's a worksheet for that that leads you through the process. I don't understand the part about
line 7 on 6251............line 7 and all the other lines in the first part are added together so wouldn't that increase the AMTI...........backing out sounds to me like it reduces something.
randomguy
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Re: State tax deducation & AMT

Post by randomguy »

kaneohe wrote:
Two Headed Mule wrote:
randomguy wrote:
Two Headed Mule wrote:
Sagenick48 wrote:But in AMT your state tax deductions are supposedly not deducted. So what is being recalculated?
You recalculate under the AMT and regular tax rules. Most commonly, a benefit occurs because decreasing the deduction for state income tax in the prior year will increase your regular tax enough to take you out of AMT. Suppose you calculate your tax as follows:

AMT rules: $50,000
Regular rules: $49,000

You pay the larger of the two -- $50,000 (technically, your AMT liability is $1,000 -- this is the terminological problem that's been referenced above). Now suppose that the next year you get a refund of $8,000 in state income tax. Did that $8,000 refund provide a tax benefit in the prior year?

As you point out, decreasing state income tax by $8,000 in the prior year will usually not change the result under the AMT rules ($50,000) since state income tax is an AMT preference item (and so was never deducted to begin with), but what about the regular tax calculation? Suppose you were in the 25% bracket (to keep the math simple) that year. Decreasing state income tax by $8,000 would increase the tax as calculated for regular purposes from $49,000 to $51,000. So taking the $8,000 deduction in the prior year saved you $1,000 in tax. But at a tax rate of 25%, only the last $4,000 of the deduction provided any tax benefit -- so only $4,000 should be included in income the next year.

Mule

Is that right? My understanding is that you would take all 8k as income when doing your taxes under then normal tax code. When you got to do AMT the tax refund would show up on line 7 of 6251 and be subtracted from your AGI. If you are always in AMT land this doesn't change much. If your alternating back and forth between normal and AMT land, I could see this being an issue. The solution is to stop giving your governments interest free loans:)
Only the amount that provided a tax benefit shows up on line 10 of your 1040, not the full amount of the refund (so $4,000 in the admittedly crude example above). If there was no tax benefit at all, there is no inclusion. Whatever the amount is, it will always be backed out on line 7 of form 6251 because that amount gave no benefit under AMT in the prior year.

Mule
I think I understand the part about line 10 of 1040................there's a worksheet for that that leads you through the process. I don't understand the part about
line 7 on 6251............line 7 and all the other lines in the first part are added together so wouldn't that increase the AMTI...........backing out sounds to me like it reduces something.
The lines in () means the amount is a negative. You basically start with AGI, add in most the deductions (except mortgage and charity) and then subtract off the state tax refund.

I am still not sure I buy that you can just count the part that gives you a tax benefit. I don't see that anywhere in the Line 10 table and heck I am not even sure how that would work. If you have 10k of real estate tax and 10k of state tax, but you can only deduct 16k, how do you figure if the last 10k comes from your real estate or income tax? There tends not to be much communication from the AMT side back into the normal tax code.
kaneohe
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Re: State tax deducation & AMT

Post by kaneohe »

randomguy wrote:
kaneohe wrote:
Two Headed Mule wrote:
randomguy wrote:

Is that right? My understanding is that you would take all 8k as income when doing your taxes under then normal tax code. When you got to do AMT the tax refund would show up on line 7 of 6251 and be subtracted from your AGI. If you are always in AMT land this doesn't change much. If your alternating back and forth between normal and AMT land, I could see this being an issue. The solution is to stop giving your governments interest free loans:)
Only the amount that provided a tax benefit shows up on line 10 of your 1040, not the full amount of the refund (so $4,000 in the admittedly crude example above). If there was no tax benefit at all, there is no inclusion. Whatever the amount is, it will always be backed out on line 7 of form 6251 because that amount gave no benefit under AMT in the prior year.

Mule
I think I understand the part about line 10 of 1040................there's a worksheet for that that leads you through the process. I don't understand the part about
line 7 on 6251............line 7 and all the other lines in the first part are added together so wouldn't that increase the AMTI...........backing out sounds to me like it reduces something.
The lines in () means the amount is a negative. You basically start with AGI, add in most the deductions (except mortgage and charity) and then subtract off the state tax refund.

I am still not sure I buy that you can just count the part that gives you a tax benefit. I don't see that anywhere in the Line 10 table and heck I am not even sure how that would work. If you have 10k of real estate tax and 10k of state tax, but you can only deduct 16k, how do you figure if the last 10k comes from your real estate or income tax? There tends not to be much communication from the AMT side back into the normal tax code.
Ah so! The light comes to he who looks but does not see................thanks for the enlightenment.

As I see it, the Line 10 Wksht pertains only the normal tax and the wksht is just comparing the std deduction against the itemized.
If the itemized exceeds the std, then you benefited from the state tax deduction. For the normal tax, all of the deduction is allowed so it doesn't matter which tax comes first.
Two Headed Mule
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Re: State tax deducation & AMT

Post by Two Headed Mule »

randomguy wrote:
I am still not sure I buy that you can just count the part that gives you a tax benefit. I don't see that anywhere in the Line 10 table and heck I am not even sure how that would work. If you have 10k of real estate tax and 10k of state tax, but you can only deduct 16k, how do you figure if the last 10k comes from your real estate or income tax? There tends not to be much communication from the AMT side back into the normal tax code.
From the IRS above:

"Subject to alternative minimum tax. If you were subject to the alternative minimum tax in the year of the deduction, you will have to re-compute your tax for the earlier year to determine if the recovery must be included in your income. This will require a recomputation of your regular tax, as shown in the preceding example, and a recomputation of your alternative minimum tax. If inclusion of the recovery does not change your total tax, you do not include the recovery in your income. However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year."

Understanding that an IRS pub is not the law (although I can vouch that this is an accurate statement of it), what this tells us to do is to recompute the prior year tax and see if it increases. The underlined part says that if the recomputation does not increase total tax, there is no inclusion. Period. So that is obviously not consistent with the notion that you simply always include a recovery in income. Now, if total tax does in fact increase, again you do not automatically include the full refund. Rather you "include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year." In my example earlier (again, admittedly simplistic), that is exactly what was computed. Total tax increased by $1,000 as a result of the recomputation, but the "deduction that reduced your tax in the earlier year" (i.e., that saved the $1000 in tax) was in fact (in the 25% bracket) only $4,000, not $8,000.

The worksheet for line 10 in the instructions does not deal with the AMT, but it is nonetheless instructive because it addresses the exact same issue in a different context. That worksheet addresses this situation:

Standard deduction: $10,000
Itemized deductions (all State tax): $12,000
Refund next year of state tax: $5,000

One might think that the full $5,000 is included in income in the year of the refund. But the worksheet tells you that, in fact, only $2,000 is included. Why? Because that is the amount that gave you a tax benefit in the prior year. That is, you could have always claimed the standard deduction of $10,000 without any recapture, so the worksheet tells you that the benefit you got from itemizing was limited to $2,000 and so that is all that must be recaptured.

Mule
Sagenick48
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Re: State tax deducation & AMT

Post by Sagenick48 »

Mule, from what I read I think we are close to identifying the problem. In AMT you don't have the standard deduction issue, so in effect you will always have the deduction equaling the recovery.

kanohe made a good observation who he said that the simple soluion is not to get a state tax refund, which works assuming you don't have issues with tax penalties.

The problem as I see it is the example that I gave of a $2000 deduction creating a $1 tax benefit. Whether it is a caused by rounding calculations, other calculations under AMT such as the capital gains portion, the way the IRS form works, or the way tax software does the computations.

The way Turbo tax calculates it, if you are in AMT in year of the $2000 deduction, a $1 tax benefit results in the recovery
of the $2000 being taxed the next year. So, is the program correct?
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Epsilon Delta
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Re: State tax deducation & AMT

Post by Epsilon Delta »

Sagenick48 wrote:
The problem as I see it is the example that I gave of a $2000 deduction creating a $1 tax benefit. Whether it is a caused by rounding calculations, other calculations under AMT such as the capital gains portion, the way the IRS form works, or the way tax software does the computations.

The way Turbo tax calculates it, if you are in AMT in year of the $2000 deduction, a $1 tax benefit results in the recovery
of the $2000 being taxed the next year. So, is the program correct?
As I understand it you are allowed to re-compute with $1999, $1998, ... , $1 deduction and if any of them results in the same (or more) tax as the $2000 the remainder has no tax benefit. Turbo tax apparently doesn't do this. You probably don't want to do an exhaustive search, but knowing something about how the taxes are calculated might allow a more efficient search (e.g. interval halving, or for a rounding error start at the bottom and work up. If there is a rounding issue there may be a low deduction that rounds the same way.)
Two Headed Mule
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Re: State tax deducation & AMT

Post by Two Headed Mule »

Sagenick48 wrote:Mule, from what I read I think we are close to identifying the problem. In AMT you don't have the standard deduction issue, so in effect you will always have the deduction equaling the recovery.

kanohe made a good observation who he said that the simple soluion is not to get a state tax refund, which works assuming you don't have issues with tax penalties.

The problem as I see it is the example that I gave of a $2000 deduction creating a $1 tax benefit. Whether it is a caused by rounding calculations, other calculations under AMT such as the capital gains portion, the way the IRS form works, or the way tax software does the computations.

The way Turbo tax calculates it, if you are in AMT in year of the $2000 deduction, a $1 tax benefit results in the recovery
of the $2000 being taxed the next year. So, is the program correct?
No, the program is almost certainly not correct.

MarkNYC already addressed what appears to be your actual situation: if you in fact amended your 2012 return to claim the general sales tax deduction in lieu of the state income tax deduction, any recovery in 2013 of state income tax is not taxable.

If the question is whether, hypothetically, you had claimed a state income tax deduction in 2012 and then in 2013 received a refund of $2,000, which only saved you $1 of tax in 2012 (and assuming this isn't a weird rounding or input error), it will almost certainly be the case that some lesser deduction in 2012 would have also saved that $1, in which case only that lesser amount is includable. That is, if you find that taking a $4 deduction (instead of $2,000) saved the same $1, the remaining $1,996 provided no tax benefit and is therefore not includable.

Mule
MarkNYC
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Re: State tax deducation & AMT

Post by MarkNYC »

Epsilon Delta and Mule have given good explanations above. In some AMT situations, where the correct taxable refund is more than zero but less than the full refund, in order to get the correct refund amount it may be necessary to go back into the prior year return and, through trial and error, determine the exact dollar amount of deduction that produced the tax benefit. There are commercial tax programs more sophisticated than TurboTax that cannot do this calculation correctly, so it would not be surprising if TurboTax cannot do it either.
Sagenick48
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Re: State tax deducation & AMT

Post by Sagenick48 »

This has been quite an education. Thanks to all you folks for the feedback and information.

I thought I would share the results, plus this will allow me to and make sure I did it right, so point out any errors.

I went back to my originally filed 2012 return (which I had saved) and recalculated the regular tax and AMT.

Basically this was pretty simple because all I had to do was take the recovery amount received 2013 which was $1281and reduce line 5 of Schedule A by that amount. The one advantage of TurboTax is that is does these calculations incredibly fast.

That changed the Form 1040 Line 46 tax by $11 and the line 55 tax by $14 (there was a $3 increase in foreign tax credits that otherwise would have to be carried forward). I assumed I needed to use the Line 55, but in the end that was not significant.

Then as per MarkNYC I used trial and error to get to the point where the $14 delta disappeared. It basically happened as a “cliff.” At $888 the delta was $14. At $889 the delta disappeared.

So as I understand it, then the amount of the refund that would have been taxable in 2013 would have been the $888, since I received a $14 tax benefit from that portion of the deduction/recovery amount.

Does this sound right?
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Two Headed Mule
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Re: State tax deducation & AMT

Post by Two Headed Mule »

Sagenick48 wrote:This has been quite an education. Thanks to all you folks for the feedback and information.

I thought I would share the results, plus this will allow me to and make sure I did it right, so point out any errors.

I went back to my originally filed 2012 return (which I had saved) and recalculated the regular tax and AMT.

Basically this was pretty simple because all I had to do was take the recovery amount received 2013 which was $1281and reduce line 5 of Schedule A by that amount. The one advantage of TurboTax is that is does these calculations incredibly fast.

That changed the Form 1040 Line 46 tax by $11 and the line 55 tax by $14 (there was a $3 increase in foreign tax credits that otherwise would have to be carried forward). I assumed I needed to use the Line 55, but in the end that was not significant.

Then as per MarkNYC I used trial and error to get to the point where the $14 delta disappeared. It basically happened as a “cliff.” At $888 the delta was $14. At $889 the delta disappeared.

So as I understand it, then the amount of the refund that would have been taxable in 2013 would have been the $888, since I received a $14 tax benefit from that portion of the deduction/recovery amount.

Does this sound right?
Seems like an odd result, but a possible one. In the usual case it will take less than $889 to save $14 in tax, but code provisions interact in odd ways, there are cliff provisions, etc. In cases where the result is somewhat unexpected, I feel more comfortable if I can identify the dynamics that are causing the result in question.

Mule
Sagenick48
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Re: State tax deducation & AMT

Post by Sagenick48 »

Seems like an odd result, but a possible one. In the usual case it will take less than $889 to save $14 in tax, but code provisions interact in odd ways, there are cliff provisions, etc. In cases where the result is somewhat unexpected, I feel more comfortable if I can identify the dynamics that are causing the result in question.

Mule[/quote]

Mule, you are absolutely right, it seems like an odd result, but I believe that is the impact of the tax benefit rule. The state taxes are not deductible under AMT so how the calculations are being done could be as simple as rounding a number. Is it .5038 cents or .4985 cents?

The alternatives are, not being over withheld, not electing to receive a tax refund (carryover your overpaid taxes to the next years return, I think that works and does not generate a 1099) or electing, as I did, the state sales tax deduction versus the income tax deduction.. SsCritic has pointed out in a PM that you can play with the decductible numbers to minimize the effect of AMT.

Regardless, My point at the very beginning was that if you are in AMT the "normal" rules don't apply and you have to be careful.

In my situation it wasn't significant, even if I was "double" taxed on $888 of income it was not the end of the world. But for the person who had a $10,000 refund. It starts adding up to real dollars.
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