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Merlo
Merlo, Accountant
Category: Tax
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Experience:  25+ years tax consulting. Specializing in returns for US citizens living abroad
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My deceased father won a 20-year-old tax refund with interest

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My deceased father won a 20-year-old tax refund with interest last year that went to me as the trustee for his estate. This is how I handled it on my 1040 form this week: I put the interest on line 21 rather than including it on line 8a. I put the legal fee for obtaining the refund on line 23 of Schedule A rather than on line 28. This seemed reasonable to me. Then came the interesting part--the AMT. Line 8 says to deduct any tax refund from Form 1040, line 10 or line 21. In reading the instructions for that line, it appears that you can only deduct a state or local tax refund, not a federal tax refund. Not only that, line 5 says to add in miscellaneous deductions from Schedule A, line 27, which is the total of lines 21-23 minus 2% of AGI. So if I'm reading all of this right, I have to add back in the lawyer's fee, but I can't subtract out the interest from the tax refund. I was all right with the extra tax from the 1040, but I'm getting killed by the AMT. Anything I can do?
Submitted: 5 years ago.
Category: Tax
Expert:  Merlo replied 5 years ago.
Hello rock,

First, the interest should have been reported on line 8a and not on line 21. Interest income is always reported on line 8a, regardless of how the interest came about.

The attorney fee should be listed on line 23 of Schedule A and is subject to the 2% floor on deductions in that category. This is true of all attorney fees in connection with any type of settlement.

If the refund you received was for federal taxes which were overpaid, then you do not list that refund anywhere as income. The only time you would list a tax refund as income is if it were a refund of state or local taxes. You should only be reporting the interest you received as income and taking a deduction for the attorney fees.

If this was helpful please press the Accept button.

Thank you.

Customer: replied 5 years ago.
So basically, you're saying I'm stuck paying the exorbitant AMT on the interest because I have to add back in the lawyer's fee on line 5. Is that true? Is that fair? There's no way around it? Also, if I report the interest on line 8a, who do I list as the payer--the IRS?
Expert:  Merlo replied 5 years ago.
Hello rock,

Yes, you would report the interest as being paid by the IRS.

As far as the issue with the AMT, I do completely understand your frustration here, but unfortunately that is exactly how this works. There is nothing I can tell you that would avoid this that is legal. The only time that attorney fees are not an issue with AMT is if they are deductible against royalty income.

I wish I could give you a solution to your problem, but these are the current regulations. I am not saying they are fair, but unfortunately I have no control over the IRS regulations.

Customer: replied 5 years ago.
OK. Now that I am resigned to having to pay this unfair AMT (when it should have been my father's money in the first place!), I have one more question. Since this was issued to his SS# XXXXX than mine, should I attach a note explaining the situation, or a copy of the lawyer's letters (which also state their fees)? The IRS said what I am doing is legal to avoid paying estate tax on a separate estate tax form, since they issued it to me as the trustee of his estate, but I should include an explanation.
Expert:  Merlo replied 5 years ago.
Hello again rock,

Yes, if the payment was issued under your father's SS number then you do have to attach an explanation to the IRS, and should include a copy of the notice that you received with your father's SS number listed.

You will not need to include a copy of the attorney letters, but should retain that information with your tax files in the event you were ever to be audited on this particular return.



Merlo, Accountant
Category: Tax
Satisfied Customers: 9783
Experience: 25+ years tax consulting. Specializing in returns for US citizens living abroad
Merlo and 3 other Tax Specialists are ready to help you
Customer: replied 5 years ago.
OK. I wish you could have brought me happier news, but I appreciate the quick, straightforward responses. Thank you!

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Merlo
Merlo
Tax Professional
9783 Satisfied Customers
25+ years tax consulting. Specializing in returns for US citizens living abroad