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George Saenz, the Bankrate.com Tax Talk columnist Alternative minimum tax and state tax refund

Dear Tax Talk,
I was subject to the AMT tax in 2005. I itemized my deductions and I also received a state tax refund for 2005 (I used TaxCut software).

When doing my 2006 return, when I entered the amount of my state tax refund on line 10 of Form 1040, the software informed me that because I paid the ATM last year I may not have to claim the entire amount. It stated that I would have to re-compute my 2005 return.

I tried looking for directions on IRS Publication 525 and I even called the 800 number for IRS and the person I spoke to was unable to help me figure out how to calculate the right amount. Can you tell me what I would need to do to determine the amount of my state tax refund to claim? Thank you.
-- Denice

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Dear Denice,
First, we have to clarify some of your abbreviations. ATM is a cash machine where you get money. Alternative minimum tax, or AMT, is a cash machine where the government gets money. Under AMT some of the deductions Congress allows you for regular taxes are taken away and thus you pay taxes under an alternative regimen.

One of the tax deductions not allowed for AMT is the deduction for all taxes on Schedule A. Since this includes your deduction for state and local income taxes, you may not have received any tax benefit from the deduction in the first place. Tax benefit means that by claiming the deduction it did not alter the amount of taxes you paid. Hence the need to refigure your tax return for 2005. Hopefully, you still have the tax program and your data file. Where would we be without computers? Maybe the tax law would be simpler?

What you need to do in refiguring your 2005 taxes is reduce your deduction for state and local income taxes on last year's Schedule A by the amount of the refund you subsequently received. If this does not alter your federal refund or tax due in 2005, you did not receive any tax benefit. None of your refund is taxable in 2006.

If the change of your state refund amount does also change your federal tax liability, either by producing a larger refund or larger bill, then your homework is more complicated. You will need to complete work sheet 2, on page 22 of IRS Publication 525. You should buy a more sophisticated tax program that will walk you through the work sheet steps. Alternatively, you can give up and let the IRS have the tax on your refund.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.

Bankrate.com's corrections policy -- Posted: April 6, 2007
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