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Sunday, October 11, 2009

More on the Tax Consequences of President Obama's Nobel Prize

Nobel Leonard E. Burman (Syracuse University, Maxwell School) follows up on Friday's post, Tax Consequences of President Obama's Nobel Prize:

Ellen Aprill's analysis of President Obama's Nobel Prize is fascinating, but left out an important factor in favor of using § 74(b) to avoid the recognition of income. If the president claims the prize as income and then makes a charitable contribution, he'll pay more tax because of the § 68 limitation on itemized deductions. The $1.4 million increase in income will reduce President Obama's itemized deductions by $42,000 (3% of $1.4 million), raising his taxes by $14,700. The problem arises because income is effectively taxed at a higher rate than deductions for people subject to the deduction phase-out.

Other phase-outs cause the same problem. AMT taxpayers in the § 55 phase-out range for the AMT exemption, for example, can face a big tax hit if they include an honorarium or award in income and then make an equal gift to charity. Every dollar transfered reduces the AMT exemption by 25 cents, costing 6.5 or 7 cents in tax depending on whether the taxpayer is in 26% or 28% AMT bracket. (This example has particular salience for me.)

I won't cry myself to sleep thinking about the president's extra tax burden because he can reduce other charitable contributions if he wants, but it is another example of how complex and counter-intuitive our tax system can be.

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Comments

Oh, come on, he is a high level Democrat.
It has been well established that he doesn't have to pay taxes.

Posted by: EvilDave | Oct 11, 2009 2:15:59 PM

At least Obama won't have any tax issues when he wins the Heisman Trophy.

Posted by: Woody | Oct 11, 2009 9:16:43 PM

Phase-outs are effectively taxes on adjusted gross income, with no allowance for any deductions. The health care bill adds another huge phase-out of the subsidy for purchasing health insurance.

We now have an income tax based partially on taxable income and partially on gross income, increasingly shifting toward gross income. In terms of tax equity, this is regressive, taking us farther from the goal of horizontal equity.

Posted by: AMTbuff | Oct 11, 2009 11:23:31 PM

The the itemized deduction phase-out for 2009 is based on 1% of the AGI in excess of the threshold so $1.4 million would only reduce itemized deductions by $14,000 not $42,000 as Mr. Burman suggested. Furthermore, Section 68 shall not apply to any taxable year beginning after December 31, 2009.

Oh Paul, look at the bright side. You can exclude 100% of a tax refund from an overpayment that was allowed as a deductions in a prior year when the regular tax was paid under paragraphs (1), (2), or (3)of 164(a) of the the IRC courtesy of IRS. I still believe that section 56(b)(1)(D) means exactly what it says.

Posted by: WD Kebschull | Oct 11, 2009 11:45:16 PM

Let's try this one more time! Courtesy of IRS a taxpayer can exclude from altermative minimum taxable income 100% of a tax refund from an overpayment that was allowed as a deduction under paragraphs (1), (2), or (3) of section 164(a) of the IRC in a prior year when the regular tax was paid. As a consequence, neither the income nor the refund related to the tax overpayment is taxed directly. However, the income and the refund may used to phase-out medical expense deductions per IRS instructions.

I still believe that section 56(b)(1)(D) means exactly what it says and it is not what is relected in the instruction on line 8 of Form 6251(2008)in most cases.

Here is section 56(b)(1)(D)

(D) Treatment of certain recoveries
No recovery of any tax to which subparagraph (A)(ii) applied shall be included in gross income for purposes of determining alternative minimum taxable income.

And 56(b)(1)(A)(ii) provides,

b) Adjustments applicable to individuals
In determining the amount of the alternative minimum taxable income of any taxpayer (other than a corporation), the following treatment shall apply (in lieu of the treatment applicable for purposes of computing the regular tax):
(1) Limitation on deductions
(A) In general
No deduction shall be allowed -
---
(ii) for any taxes described in paragraph (1), (2), or (3) of section 164(a). Clause (ii) shall not apply to any amount allowable in computing adjusted gross income.

Here are some clues:

1. For a recovery of a tax to which subparagraph (A)(ii) applied to be included on either line 10 or 21 of Form 1040, the tax overpayment must have reduced the capital gains portion of the AMT. See page 2 of Form 6251 and IRS Publication 525.

2. Now reflect on what happens when a tax overpayment produces a tax benefit by reducing the capital gains portion of the AMT and the taxpayer pays only the regular tax in the year the refund is received.


Posted by: WD Kebschull | Oct 12, 2009 3:08:54 PM