State & Local Tax Alert: Alabama Edition

Two weeks ago, the Baldwin County Circuit Court entered an order dismissing the Alabama Department of Revenue’s (ADOR) appeal from the February 2017 decision by the Alabama Tax Tribunal in Moody v. Alabama Department of Revenue, and ordering a refund of the tax overpayment.

Readers may recall that the issue in Moody was whether the additional limitation the ADOR began imposing in 2013 on an Alabama resident’s income tax credit for taxes paid to other states was valid. Historically, the credit was limited to the lesser of the amount of taxes actually paid (directly or indirectly by an owner’s pass-through entity) to another state or the amount of income tax due on the income attributable to that state using the applicable Alabama income tax rates (i.e., 5 percent). However, effective January 1, 2013, Department Rule 810-3-21-.03 limits the allowable credit for taxes paid to other states by requiring it to be calculated by multiplying the tax paid to other states by a fraction: total non-Alabama AGI divided by total Alabama AGI (the “percentage limitation”). The percentage limitation limits the amount of credit available based on Alabama’s effective tax rate (i.e., the rate after a taxpayer claims his or her federal income tax deduction). That limitation in effect caused many Alabama residents to lose part of their FIT deduction, which is embedded in the Alabama Constitution.

In filing their 2013 income tax return, the Moodys did not follow the 2013 Schedule CR, which had been amended to include the percentage limitation. Rather, they calculated the credit in the same manner as in prior years. Upon review of the Moodys’ 2013 Alabama income tax return, the ADOR recalculated the credit for taxes paid to other states by imposing the percentage limitation, thus causing the Moodys to have underpaid their Alabama income tax liability. The ADOR then entered a final assessment, which the Moodys timely appealed to the Alabama Tax Tribunal.

Relying on longstanding Alabama Supreme Court precedent, Chief Tax Tribunal Judge Bill Thompson concluded that the percentage limitation imposed by Rule 810-3-21-.03 exceeded the scope of the statute on which it was purportedly based, Ala. Code § 40-18-21. Judge Thompson found that the additional percentage limitation imposed by Rule 810-3-21-.03 unlawfully reduced the credit and resulted in double taxation of a portion of the Moodys’ non-Alabama source income. As a result, Judge Thompson ruled that the final assessment was void.

The ADOR appealed Judge Thompson’s decision to Baldwin County Circuit Court. Just prior to a hearing on a motion for summary judgment filed by the Moodys, the Circuit Court, upon a joint motion by the parties, entered an order dismissing the appeal. The court also ordered the ADOR to “process the 2013 Alabama income tax return filed by the [Moodys] and refund the amount of the overpayment shown on the return, along with applicable interest…” Effectively, this order affirmed Judge Thompson’s earlier opinions in Moody, invalidating the percentage limitation contained in Rule 810-3-21-.03. It is likely that legislation will be pursued next session (which begins January 9) to address this issue by statute. It is unknown whether any proposed legislation would be retroactive in effect.

Our firm was pleased to serve as amicus counsel for the Alabama Society of CPAs on behalf of the Moodys before the Alabama Tax Tribunal, and we represented the Moodys in the ADOR’s appeal to the Baldwin County Circuit Court.