United States

Alabama tribunal rejects rule limiting individual income tax credit

Taxes paid to other states calculation was contrary to the statute

TAX ALERT  | 

On Sept. 29, 2016, the Alabama Tax Tribunal issued its decision in Moody v. Alabama Department of Revenue (DOR), rejecting the DOR’s regulatory scheme limiting the individual tax credit for income tax paid to other states. The Tribunal found that the limitation based on a ratio of non-Alabama adjusted gross income and total Alabama adjusted gross income was contrary to both the controlling Alabama statute and the legislative intent to relieve the taxpayer of the burden of double taxation.

The taxpayers filed a 2013 Alabama income tax return claiming a credit for 2013 Mississippi income tax paid of $29,439, based on taxable income of $594,772 reported to Mississippi in that year. The DOR reduced the allowable credit to $18,145, citing the limitations outlined in Alabama Regulation 810-3-21-.03 (Maximum Credit for Tax Paid other Jurisdictions), and accordingly assessed additional tax.

The Tribunal noted that the limitations outlined in Regulations 810-3-21-.03(1) and (2) and the supporting examples were not allowed by the controlling Alabama statute, Ala. Code section 40-18-21 (Credits for taxes paid on income from sources outside the state and for job development fees). The statute specifically limits the amount of the credit to only the amount of tax that would have been due on the same income under Alabama’s tax rates. The Tribunal provided the following example to illustrate the statutory limitation:

An Alabama resident with $10,000 of income in State B, with a tax rate of 7 percent, pays $700 of income tax to that state. Pursuant to the statutory limitation, the Alabama credit would be limited to $500, or the amount that would have been paid on the same income pursuant to Alabama's 5 percent rate.

The statute expressly limits the credit to $500 in this example. However, the statute contains no provisions allowing for the limitation based on non-Alabama income and total Alabama income prescribed in Regulation 810-3-21-.03.

Through a computation laid out in its decision, the Tribunal demonstrated that the limitations in Regulation 810-3-21-.03 exceed the authority of the statutory provision in Ala. Code section 40-18-21 by producing a different limitation than that provided in the statute and resulting in an application of the credit that essentially imposes two state income taxes on one income. Citing State v. Robinson Land & Lumber, where the Alabama Supreme Court struck down a similar limitation application provided for by an earlier statute, the Tribunal found that “the legislative purpose in the adoption of the credit provision in our statute…was to relieve the taxpayer of the burden of double taxation.” The Tribunal’s computation demonstrated how a taxpayer could be liable for an effective state tax rate higher than 5 percent, which indicated that at least a portion of the resident's income would be taxed twice by applying the methodology in Regulation 810-3-21-.03.

Takeaways

The Alabama DOR has 30 days from the date of the order to appeal the decision to circuit court. Alabama resident individuals who pay taxes to other jurisdictions should carefully review the Tribunal’s order and consider whether its rejection of Regulation 810-3-21-.03 could change their income tax liability. Affected taxpayers may consider adjusting their tax filing positions for original returns. Regulation 810-3-21-.03 was effective for tax years beginning on or after Jan. 1, 2013, therefore, taxpayers may also consider the possibility of refund claims for affected tax years.

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