Alabama Tax Tribunal Rejects Regulation Limiting Credit for Taxes Paid to Other State
Taxpayers with multi-state income have refund potential for prior years

By:  Kim Smith, CPA, Tax Shareholder

Kim is a shareholder, a member of the JMF Tax Department and in charge of the JMF State and Local Tax (SALT) group.  With over 20 years of experience, she assists clients with corporate, partnership, and individual income tax reporting as well as complex multi-state income and sales tax issues.

 

Do you pay income taxes to Alabama and another state?  The Alabama Tax Tribunal has rejected the way a 2013 Alabama Regulation limits your Alabama tax credit for taxes paid to another state(s).

Alabama Code Section 40-18-21 allows Alabama residents who have gross income from sources outside Alabama that are taxable in both Alabama and another state a credit against the income tax due to Alabama for taxes paid in the other state.  The credit allowed is the lesser of the tax paid to the other state on the income, the tax due on the income using Alabama tax rates or the tax due with the return.

In Moody v. State of Alabama Department of Revenue, the taxpayers filed a 2013 income tax return claiming a credit for taxes paid to another state. The Department reviewed the return, reduced the credit claimed and entered a final assessment.

Beginning in January 2013, the Revenue Department issued Regulation 810-3-21-.03 which introduced an additional limit on the amount of credit available to taxpayers.  The regulation provides that in computing the allowable credit, the income tax paid to another state must be multiplied by a percentage, the numerator of which is total non-Alabama adjusted gross income and the denominator of which is total Alabama adjusted gross income.

Regulation 810-3-21-.03(1) and (2) gives the following example:

Taxpayer reports $120,000 of adjusted gross income on his Alabama income tax return, of which $80,000 is attributable to another jurisdiction; his Alabama income tax liability before credits is $4,000.  Taxpayer paid the other jurisdiction $4,000 of income tax on the $80,000 of income from the other jurisdiction.

The maximum credit that the Taxpayer may utilize is $2,667, which is the portion of his liability attributable to other jurisdictions.  Because one-third ($1,333) of Taxpayer’s liability is attributable to Alabama sources, it is not subject to the credit for tax paid to other jurisdictions.

Prior to the 2013 regulation, the second paragraph limitation was not in effect and the taxpayer would have received a credit of $4,000 on his Alabama income tax return.  The tribunal ruled on September 29, 2016 in Moody v. State of Alabama that the 2013 regulation imposed a limit not included in Code Section 40-18-21 and voided the assessment.  The court stated “The intent of the credit provision is for an Alabama resident taxpayer with foreign-sourced income to pay to Alabama the amount that would have been owed to Alabama if the taxpayer had omitted the foreign sourced income from the return.  The percentage limitation in Reg. 810-3-21.03 thwarts that intent.”

The decision in Moody v. State of Alabama creates a potential refund opportunity for Alabama residents who claimed a credit for taxes paid to another state on their Alabama individual income tax returns.  The State of Alabama has applied for a rehearing through the Tribunal and may eventually appeal the decision.  Protective refund claims should be considered to stop the statute of limitations from running for 2013.

If you have any questions about this ruling or any state and local tax issue, please do not hesitate to call your JMF tax professional.