AMT and taxable portion of state tax refund

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ryman554
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AMT and taxable portion of state tax refund

Post by ryman554 » Tue Jan 10, 2017 1:03 pm

I want to make sure I understand this..

It has been my understanding that, since the state tax is a disallowed deduction for AMT purposes, the refund from the state for overpayment of state taxes is not taxed.

Since my AMT amount has always been larger than my state tax refund, I never bothered to go back and compute it. This year I'm closer.

Am I correct in doing the following:
1. Compute taxes for 2016 as normal. Find out the AMT hit.
2. Re-Compute federal taxes for 2016, reducing the state deduction by the amount refunded for over-payment. See the new tax value.

If #1 = #2, then the entire state refund is not taxable income for 2017.
If #2 is less than #1, now what? Do I start iterating on the value until I get the state tax deduction that is tax neutral for 2017?

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CAsage
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Re: AMT and taxable portion of state tax refund

Post by CAsage » Tue Jan 10, 2017 1:30 pm

The AMT is truly ugly. It is my understanding the AMT takes your "net" taxes paid for the year. In my case, it takes my CA state taxes paid that year, plus my property taxes, and then subtracts my tiny CA state refund. So, in a sense it appears your tax refund is not impacted.... but it's really just offsetting whatever you paid. I would strongly suggest you get a real tax program, and enter it one way and then another, and then print out Form 6251 in both cases to understand it.
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Edited to add: State tax refunds are taxable income; the AMT just calculates a higher tax without that deduction.
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MarkNYC
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Re: AMT and taxable portion of state tax refund

Post by MarkNYC » Tue Jan 10, 2017 2:46 pm

ryman554,

Your analysis is correct. A refund of state tax that was deducted in the prior year is a "recovery" in IRS language, and is taxable in the year received up to the amount by which the deduction reduced your tax in the earlier year. Usually a state tax refund is either fully taxable, or fully nontaxable if subject to AMT in the prior year. Occasionally, when the refund is large and the AMT the prior year is small, part of the state tax deduction reduced prior year federal tax and part did not, so only a portion of the state tax refund is taxable.

I'm not saying they don't exist, but I have not seen a tax program that computes this correctly when only part of the refund is taxable. Most programs will incorrectly assume the refund is fully taxable if the deduction produced ANY federal tax benefit the prior year. If any consolation, IRS tax return programs also don't seem to be able to do the correct calculation, so taxpayers rarely if ever receive an IRS notice indicating an incorrect refund amount was included in income.
Last edited by MarkNYC on Tue Jan 10, 2017 3:03 pm, edited 1 time in total.

Good Listener
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Re: AMT and taxable portion of state tax refund

Post by Good Listener » Tue Jan 10, 2017 2:58 pm

I can only say that I always pay AMT and somehow the tax software declares is all to be taxable. I used to think (hope) what you initially thought. I now try to avoid overwithholding although I did it again by a few thousand this year. I hope they get rid of the AMT, what a nuisance and it gets in the way of rational tax planning.

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Re: AMT and taxable portion of state tax refund

Post by HueyLD » Tue Jan 10, 2017 3:02 pm

ryman554 wrote:I want to make sure I understand this..

It has been my understanding that, since the state tax is a disallowed deduction for AMT purposes, the refund from the state for overpayment of state taxes is not taxed.

Since my AMT amount has always been larger than my state tax refund, I never bothered to go back and compute it. This year I'm closer.

Am I correct in doing the following:
1. Compute taxes for 2016 as normal. Find out the AMT hit.
2. Re-Compute federal taxes for 2016, reducing the state deduction by the amount refunded for over-payment. See the new tax value.

If #1 = #2, then the entire state refund is not taxable income for 2017.
If #2 is less than #1, now what? Do I start iterating on the value until I get the state tax deduction that is tax neutral for 2017?
If you use a tax software, it can be done after a few iterations. Keep in mind that if you were subject to AMT, you were probably subject to various phaseouts and limitations based on the AGI and the inclusion of taxable state tax refund changes the AGI.

Good luck "playing" with numbers.

NotWhoYouThink
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Re: AMT and taxable portion of state tax refund

Post by NotWhoYouThink » Tue Jan 10, 2017 3:16 pm

Oh, gosh, don't make me go back and redo this. I was in that situation one year, and I think iteration is how I got to the taxable amount.

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Artsdoctor
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Re: AMT and taxable portion of state tax refund

Post by Artsdoctor » Tue Jan 10, 2017 11:39 pm

Generally, if you've consistently been paying the AMT, a state tax refund is not taxed. If you're using Turbo Tax, and I can't say anything about other software programs, you will probably have to fill out the "recovery exclusion" described above by actively going to that form (it's called the state and local tax refund worksheet). I don't know why Turbo Tax will not automatically do it for you even when importing the previous year's return--it should.

But when you do it correctly, the state income tax refund is zeroed out on your 1040, and your AGI is not affected.

There are situations, I'm told, when your refund may be partially taxed although this has never happened to me and I understand that it's not common.

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Re: AMT and taxable portion of state tax refund

Post by grabiner » Tue Jan 10, 2017 11:51 pm

MarkNYC wrote:A refund of state tax that was deducted in the prior year is a "recovery" in IRS language, and is taxable in the year received up to the amount by which the deduction reduced your tax in the earlier year. Usually a state tax refund is either fully taxable, or fully nontaxable if subject to AMT in the prior year. Occasionally, when the refund is large and the AMT the prior year is small, part of the state tax deduction reduced prior year federal tax and part did not, so only a portion of the state tax refund is taxable.
Another common situation for a partially deductible refund occurs if your itemized deductions, reduced by the refund, are less than the standard deduction. For example, if you had $400 more than the standard deduction in itemized deductions, then only $400 of your tax refund can be taxable, because you got no benefit from anything beyond that $400.
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Re: AMT and taxable portion of state tax refund

Post by JoinToday » Wed Jan 11, 2017 12:24 am

OP's post made me wonder (without meaning to derail this thread): is there anyway to "game" the system with respect to AMT & taxes paid? (either state or fed)

Calif resident here. I adjust withholding to get as close as I can to paying the correct tax every year. I do a Roth conversion at the beginning of the year, and when I do my taxes (typically Feb or March), I recharacterize just the right amount so I pay no AMT...... less than $10 away from the AMT threshold for my income.

Is there anything to be gained from paying more in a given year so I get a refund, or a little less so I have to pay additional taxes? (assuming I pay enough to satisfy safe harbor rules). Or bunching of state/fed taxes?

Looking for all angles to legally reduce current and future taxes, with minimal impact on income. I already have a donor advised fund for charity (funded with appreciated assets), and carry forward losses to last until I die. I also do Roth conversions in the hopes of smoothing my tax burden from now until after RMDs start.
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Re: AMT and taxable portion of state tax refund

Post by RoboticOwl » Wed Jan 25, 2017 11:16 pm

After going through this process of calculating the extent, if any, that the refund resulted in a tax benefit in the prior year, how is the result to be documented? Treas. Reg. 1.111-1(b)(1) says "A taxpayer claiming a recovery exclusion shall submit, at the time the exclusion is claimed, the computation of the recovery exclusion claimed for the original year for which the items were deducted or credited, and computations showing the amount recovered in intervening years on account of the section 111 items deducted or credited for the original year." Does this require attaching the re-figured prior year regular tax and AMT calculations showing that there was no change in tax owed (in which case the entire refund is not taxable) or so much of the refund that does not result in a reduction of any tax owed?

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Re: AMT and taxable portion of state tax refund

Post by grabiner » Thu Jan 26, 2017 9:08 pm

JoinToday wrote:OP's post made me wonder (without meaning to derail this thread): is there anyway to "game" the system with respect to AMT & taxes paid? (either state or fed)

Calif resident here. I adjust withholding to get as close as I can to paying the correct tax every year. I do a Roth conversion at the beginning of the year, and when I do my taxes (typically Feb or March), I recharacterize just the right amount so I pay no AMT...... less than $10 away from the AMT threshold for my income.

Is there anything to be gained from paying more in a given year so I get a refund, or a little less so I have to pay additional taxes? (assuming I pay enough to satisfy safe harbor rules). Or bunching of state/fed taxes?
You won't gain by getting a refund, since the refund will be taxable income in the next year, and you may lose because it will count towards income-based phase-outs in the tax cost.

However, bunching might work. If you will owe AMT in 2018 but not in 2017, make an estimated state tax payment in December 2017 which will cover what you expect to be your entire liability, rather than waiting until January 2018 to make it, or paying only enough estimated tax to meet the safe harbor.

In addition, if you owe AMT, you have a different marginal tax rate, so it may be better to realize income in the AMT or non-AMT year. For example, if you take a capital gain while you are in the personal exemption phase-out for the AMT, the gain is taxed at 22%; if you take it when you pay the regular tax the next year, the gain is taxed at 15%. Conversely, if your marginal AMT rate is 28% (you are past the phase-out range) and your marginal rate for the regular tax is 33%, it's better to receive ordinary income in the AMT year.
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Re: AMT and taxable portion of state tax refund

Post by JoinToday » Fri Feb 03, 2017 2:26 pm

grabiner wrote:
JoinToday wrote:OP's post made me wonder (without meaning to derail this thread): is there anyway to "game" the system with respect to AMT & taxes paid? (either state or fed)

Calif resident here. I adjust withholding to get as close as I can to paying the correct tax every year. I do a Roth conversion at the beginning of the year, and when I do my taxes (typically Feb or March), I recharacterize just the right amount so I pay no AMT...... less than $10 away from the AMT threshold for my income.

Is there anything to be gained from paying more in a given year so I get a refund, or a little less so I have to pay additional taxes? (assuming I pay enough to satisfy safe harbor rules). Or bunching of state/fed taxes?
You won't gain by getting a refund, since the refund will be taxable income in the next year, and you may lose because it will count towards income-based phase-outs in the tax cost.

However, bunching might work. If you will owe AMT in 2018 but not in 2017, make an estimated state tax payment in December 2017 which will cover what you expect to be your entire liability, rather than waiting until January 2018 to make it, or paying only enough estimated tax to meet the safe harbor.

In addition, if you owe AMT, you have a different marginal tax rate, so it may be better to realize income in the AMT or non-AMT year. For example, if you take a capital gain while you are in the personal exemption phase-out for the AMT, the gain is taxed at 22%; if you take it when you pay the regular tax the next year, the gain is taxed at 15%. Conversely, if your marginal AMT rate is 28% (you are past the phase-out range) and your marginal rate for the regular tax is 33%, it's better to receive ordinary income in the AMT year.
Thanks David. I will have to think about this a little more & see if I can do anything to help reduce my taxes for 2017 & beyond.

1. Can a person make 2018 estimated State tax payment in December 2017? Maybe an entire year's worth of estimated State taxes in Dec 2017 for 2018 for bunching purposes.
2. The 22% tax rate for cap gains: This is the marginal rate of 15% + 6.5% (the effects of the phase out)? and then I would add 9.3% Calif tax on top of that for 30.8% total marginal rate?
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boglesmind
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Re: AMT and taxable portion of state tax refund

Post by boglesmind » Fri Feb 03, 2017 3:19 pm

RoboticOwl wrote:Does this require attaching the re-figured prior year regular tax and AMT calculations showing that there was no change in tax owed (in which case the entire refund is not taxable) or so much of the refund that does not result in a reduction of any tax owed?
Yes in its own 2016 worksheet.
I use TurboTax Premier 2016 (same as in 2015). It made me recalculate 2015 taxes using 2015 Turbotax and entering 2015 State tax refund as a negative item in one of the worksheets. Then I had to copy 2015 re-figured taxable income, ordinary tax, AMT etc to 2016 tax program (answer a few questions in interview mode). 2016 return now includes a worksheet called
Form 1040 State and Local Income Tax Refund Worksheet 2016
Line 10 State and local taxes paid in 2015 or prior years and refunded in 2016
that has sections for Recovery Amount, Recovery Exclusion Amount, and Taxable Refund.

Even though the taxable amount of 2015 refund turns out to be zero, it didn't affect the 2016 federal tax one way or another. State tax refunds so far, for me, just changed the split between regular tax & AMT in 2015 and 2016. So the 15 minutes work of redoing 2015 taxes using Turbotax was a waste for me. Could have just treated 2015 refund as taxable and be done with it. One hand takes away what the other gives. YMMV.


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Re: AMT and taxable portion of state tax refund

Post by grabiner » Fri Feb 03, 2017 11:58 pm

JoinToday wrote:1. Can a person make 2018 estimated State tax payment in December 2017? Maybe an entire year's worth of estimated State taxes in Dec 2017 for 2018 for bunching purposes.
I don't think you can pay your 2018 estimated taxes in 2017. You can pay your 2017 estimated taxes in 2017, or make the last payment in January 2018. If you can deduct the payment in 2017 but not in 2018, it is better to pay in 2017.
2. The 22% tax rate for cap gains: This is the marginal rate of 15% + 6.5% (the effects of the phase out)?
The phase-out is 7%. In the phase-out, every $4 of income reduces your personal exemption by $1, and the AMT rate is 28%, so every $4 of income leads to another $0.28 in tax. It would only be 6.5% if you had so much capital gain and qualified dividend income that your AMT marginal rate on ordinary income was 26% and your total income was high enough to be in the phase-out; this is unlikely.
and then I would add 9.3% Calif tax on top of that for 30.8% total marginal rate?
Correct, although it is 31.3%.
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Re: AMT and taxable portion of state tax refund

Post by kaneohe » Sat Feb 04, 2017 9:13 am

boglesmind wrote:.........................................

Even though the taxable amount of 2015 refund turns out to be zero, it didn't affect the 2016 federal tax one way or another. State tax refunds so far, for me, just changed the split between regular tax & AMT in 2015 and 2016. So the 15 minutes work of redoing 2015 taxes using Turbotax was a waste for me. Could have just treated 2015 refund as taxable and be done with it. ...........................


Boglesmind
Not sure I understand that last statement..........if you treat state tax refund as taxable, doesn't that increase AGI and thus tax.
I understand that under AMT, increasing the amount of state tax deducted may not change the total tax, just the mix of regular tax and AMT but I think
treating a state tax refund as taxable is a different situation?

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Re: AMT and taxable portion of state tax refund

Post by grabiner » Sat Feb 04, 2017 11:20 am

kaneohe wrote:
boglesmind wrote:.........................................

Even though the taxable amount of 2015 refund turns out to be zero, it didn't affect the 2016 federal tax one way or another. State tax refunds so far, for me, just changed the split between regular tax & AMT in 2015 and 2016. So the 15 minutes work of redoing 2015 taxes using Turbotax was a waste for me. Could have just treated 2015 refund as taxable and be done with it. ...........................


Boglesmind
Not sure I understand that last statement..........if you treat state tax refund as taxable, doesn't that increase AGI and thus tax.
I understand that under AMT, increasing the amount of state tax deducted may not change the total tax, just the mix of regular tax and AMT but I think
treating a state tax refund as taxable is a different situation?
State income tax refunds are not taxable under the AMT; see the Form 6251 Instructions. For example, suppose that you received a $1000 non-taxable state tax refund, and your tax ignoring that refund is $48,000 under the regular rules and $49,000 under the AMT rules. You thus owe $48,000 of regular tax and $1,000 of AMT. If you add that tax refund as taxable income, your tax becomes $48,280 under the regular rules (28% tax bracket assumed), but still $49,000 under the AMT rules, so you pay the same $49,000, but now it includes only $720 of AMT.

This could still make a difference if you have refundable AMT (because you have items which are taxed under both regular tax and AMT but in different years, such as incentive stock options and accelerated depreciation).
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Re: AMT and taxable portion of state tax refund

Post by kaneohe » Sat Feb 04, 2017 12:21 pm

grabiner wrote:
kaneohe wrote:
boglesmind wrote:.........................................

Even though the taxable amount of 2015 refund turns out to be zero, it didn't affect the 2016 federal tax one way or another. State tax refunds so far, for me, just changed the split between regular tax & AMT in 2015 and 2016. So the 15 minutes work of redoing 2015 taxes using Turbotax was a waste for me. Could have just treated 2015 refund as taxable and be done with it. ...........................


Boglesmind
Not sure I understand that last statement..........if you treat state tax refund as taxable, doesn't that increase AGI and thus tax.
I understand that under AMT, increasing the amount of state tax deducted may not change the total tax, just the mix of regular tax and AMT but I think
treating a state tax refund as taxable is a different situation?
State income tax refunds are not taxable under the AMT; see the Form 6251 Instructions. For example, suppose that you received a $1000 non-taxable state tax refund, and your tax ignoring that refund is $48,000 under the regular rules and $49,000 under the AMT rules. You thus owe $48,000 of regular tax and $1,000 of AMT. If you add that tax refund as taxable income, your tax becomes $48,280 under the regular rules (28% tax bracket assumed), but still $49,000 under the AMT rules, so you pay the same $49,000, but now it includes only $720 of AMT.

This could still make a difference if you have refundable AMT (because you have items which are taxed under both regular tax and AMT but in different years, such as incentive stock options and accelerated depreciation).
Thanks, grabiner........wasn't aware that state income tax refunds were not taxable under AMT (didn't notice those parentheses and was wondering why they would add that to taxable income). Also missed the fact that OP is subject to AGI in both yrs. In my case I had AMT last yr but likely not this yr. I had a small state refund from last yr and believe it is non-taxable (based on iterative returns from last yr using various state tax deductions).
In my case, if I didn't do the iterations and just input the state tax refund as income, I believe it would increase my taxes . Sound right?

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Re: AMT and taxable portion of state tax refund

Post by grabiner » Sat Feb 04, 2017 1:14 pm

kaneohe wrote:In my case I had AMT last yr but likely not this yr. I had a small state refund from last yr and believe it is non-taxable (based on iterative returns from last yr using various state tax deductions).
In my case, if I didn't do the iterations and just input the state tax refund as income, I believe it would increase my taxes . Sound right?
This is correct. Since you do not pay AMT in 2016, there is only one tax for you to compute, and a taxable refund increases that tax. You need to report the refund as non-taxable.
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Re: AMT and taxable portion of state tax refund

Post by ivk5 » Sun Oct 29, 2017 2:10 pm

For the benefit of folks who dig this post out of the archives, as i did, bumping to add link to recent post on the state tax refund / AMT topic which i find very helpful - addresses a number of nuances in different scenarios. https://www.cpajournal.com/2017/10/13/u ... efit-rule/

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Re: AMT and taxable portion of state tax refund

Post by boglesmind » Sat Dec 09, 2017 3:17 pm

boglesmind wrote:
Fri Feb 03, 2017 3:19 pm
RoboticOwl wrote:Does this require attaching the re-figured prior year regular tax and AMT calculations showing that there was no change in tax owed (in which case the entire refund is not taxable) or so much of the refund that does not result in a reduction of any tax owed?
Yes in its own 2016 worksheet.
I use TurboTax Premier 2016 (same as in 2015). It made me recalculate 2015 taxes using 2015 Turbotax and entering 2015 State tax refund as a negative item in one of the worksheets. Then I had to copy 2015 re-figured taxable income, ordinary tax, AMT etc to 2016 tax program (answer a few questions in interview mode). 2016 return now includes a worksheet called
Form 1040 State and Local Income Tax Refund Worksheet 2016
Line 10 State and local taxes paid in 2015 or prior years and refunded in 2016
that has sections for Recovery Amount, Recovery Exclusion Amount, and Taxable Refund.

Even though the taxable amount of 2015 refund turns out to be zero, it didn't affect the 2016 federal tax one way or another. State tax refunds so far, for me, just changed the split between regular tax & AMT in 2015 and 2016. So the 15 minutes work of redoing 2015 taxes using Turbotax was a waste for me. Could have just treated 2015 refund as taxable and be done with it. One hand takes away what the other gives. YMMV.

Boglesmind
In preparation for 2017 tax returns, re-did the 2016 federal return by reducing the amount of state income tax deduction in 2016 by the refund received in 2017. Because of AMT, my federal income tax didn't change - since no deduction is allowed for state income and local property taxes for AMT calculation.

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Re: AMT and taxable portion of state tax refund

Post by Electron » Sat Dec 09, 2017 3:46 pm

Take a look at Line 7 on IRS Form 6251. Line 7 is labeled "Tax refund from Form 1040, line 10 or line 21".

If you then look at the column where the data is entered, you will see parentheses (..) which indicates a negative number.
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Re: AMT and taxable portion of state tax refund

Post by lenw9 » Sat Jan 13, 2018 11:30 pm

Even Turbotax online (normally very good) tells you to redo form 6251 (AMT) and Schedule A (deductions) BY HAND without providing tables and worksheets. Their amended return software is useless to do the calculations because the revised return is like volunteering to pay more taxes, which they
assume no one does.

I almost always avoid a state refund, but had some unexpected events in 2016.

I regard this as a joke on me by Turbotax.

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