(1) If a taxpayer claims an itemized deduction for federal income taxes paid under 15-30-121(1)(b), MCA, in one tax period and subsequently receives a refund of those taxes paid in another tax period, the amount of refund that is taxable under 15-30-111(1)(b), MCA, is computed as though the taxpayer had paid the proper amount of federal tax and claimed the appropriate deduction during the period. A taxpayer whose deduction for federal income taxes was limited under 15-30-121(1)(b), MCA, for tax years beginning after December 31, 2004, would only report the portion of their refund that reduces their tax paid below the applicable limitation.

(2) The following examples illustrate the application of this rule:

(a) Example 1 - Taxpayer A pays $15,000 in federal income taxes in 2005, has no other itemized deductions, files as 'single' on his Montana state income tax return, and receives a federal refund in 2006 of $8,000. If the taxpayer had paid the proper tax during 2005, his federal taxes paid would have been $7,000. Since his Montana deduction for federal taxes is limited to $5,000 in both situations, none of the refund would be included in Montana taxable income.

(b) Example 2 - Married taxpayers B and C pay $20,000 in federal income taxes in 2005, have no other itemized deductions, file as 'joint' on their Montana state income tax return, and receive a federal refund in 2006 of $12,500. If the taxpayers had paid the proper tax during 2005, their federal taxes paid would have been $7,500. Since their Montana deduction for federal income taxes was limited to $10,000, only $2,500 of their federal refund would be included in Montana taxable income.

(c) Example 3 - Taxpayer D pays $6,500 in federal income taxes in 2005, has other itemized deductions totaling $4,500, files as 'single' on her Montana state income tax return, and receives a federal refund in 2006 of $4,100. If the taxpayer had paid the proper tax during 2005, her federal taxes paid would have been $2,400. Since her Montana deduction for federal income taxes was limited to $5,000, only $2,600 of her federal refund would be included in Montana taxable income.

(3) This rule shall be effective for tax year 2006 forward.