The Alternative Minimum Tax and You! – Part 1
The Alternative Minimum Tax (AMT) for individuals, enacted by Congress in 1969, is becoming less of an alternative for some taxpayers. The AMT was originally targeted at approximately 150 taxpayers that had high Adjusted Gross Income (AGI), but paid zero tax due to the types of income and structuring of deductions. In effect, under the current structure the AMT almost guarantees that once taxpayers reach a certain level of income, their effective tax rate will be at least 26% or higher.
The AMT is calculated by both businesses and individuals, but under different circumstances. In this post I will discuss the AMT as it applies to individuals (In the next post I will talk about how the AMT applies to businesses).
Individuals Subject to AMT
Individuals calculate their share of the AMT on Form 6251. That taxpayer begins with their AGI after itemized deductions, and then adds back the following:
- Medical expenses
- State and local income, real estate, and property taxes
- Miscellaneous deductions
The taxpayer must also add back or reduce by the difference between their income tax and AMT amounts for the following:
- Investment interest expense
- Basis in exercised incentive stock options
- Depreciation expense
Taxpayers may also have to report AMT adjustments passed through on K-1’s from their other activities (partnerships, trusts, or S-corporations).
Once all of these adjustments have been considered, the taxpayer arrives at their Alternative Minimum Taxable Income (AMTI). Taxpayers are allowed an exemption amount, which has been indexed for inflation thanks to acts by Congress at the end of 2012. The exemption amounts for 2015 are $53,600 for Single filers ($53,900 in 2016), $83,400 ($83,800 in 2016) those taxpayers who are Married and File Jointly and $41,700 ($41,900 in 2016) for Married taxpayers who file separately ($23,800 for Estate and Trusts in case you were wondering [$23,900 in 2016]). The exemption amount is subtracted from AMTI, and the resulting amount is multiplied by either 26% or 28% depending on whether the amount is above or below $185,400 ($186,300 in 2016) for Married Filing Jointly or $92,700 ($93,150 in 2016) if Married and filing separately.
If income is above that amount, it is multiplied by 28%, and 26% if not.
Once the AMT is calculated, it is compared to the regular tax calculated on the taxpayer’s Form 1040. This is where the AMT earns the name “Alternative”. Once the taxpayer compares their AMT to their regular tax, the higher amount becomes their income tax.
Why does the AMT work? Because it attacks two types of tax situations and makes them less beneficial.
First, the AMT trues up the tax rate for taxpayers that have high incomes from sources that are not taxed at regular tax rates, such as long-term capital gains, qualified dividends, and tax-exempt interest. If a taxpayer has $10 million in AGI, but it consists completely of long-term capital gains and qualified dividends, their “regular” tax rate is only 20% (in 2015) as opposed to 39.6% (in 2015). The AMT would require this taxpayer to pay a higher rate due to their high income.
Second, the AMT penalizes taxpayers with certain higher-than-normal deductions. As I mentioned above, one deduction added back for AMT purposes is state and local taxes from Schedule A. For a taxpayer living in an income tax state (a state that has their own income tax, such as New York, New Jersey, or North Carolina but not Florida), a deduction is allowed on their Federal return for state tax payments made during the calendar year. The difference
between paying the state 4th quarter estimated tax payment on December 31 instead of January 15 of the following year is that the payment will be allowed as a deduction Schedule A in the year of payment. However, making that payment before year-end will not matter if the taxpayer will be subject to AMT, because those amounts will be added back.
Can It Be Avoided?
Unfortunately, the AMT is a “Do Not Pass Go, Do Not Collect $200” situation. One simple way to forego the calculation is for the
taxpayer’s income after itemized deductions to stay below the AMT exemption amounts. Also, if the majority of the taxpayer’s income is taxed at regular rates, the AMT will not be a problem because the regular tax will most likely exceed the AMT. If a taxpayer, because of their types of income, will be subject to the AMT, they should try to avoid certain deductions (if possible) in order to minimize their AMTI. Simple planning maneuvers such as paying state taxes on January 15 of the following year and staggering the exercise of incentive stock options can minimize the amount of AMT adjustments in a given year. Taxpayers with depreciable property can elect depreciation methods that do not create large tax to AMT differences.
In all, if you are (or think you are) subject to the AMT, contact us at (845) 344-1040 or visit our web site => SolidTaxSolutions.com (open year-round) and we will help you with the impact the AMT could have on your situation, and what measures can be taken in order to minimize the AMT’s impact.
For those of you who have businesses or are planning to enter the world of entrepreneurship, stay tuned for the next post.
In – The Alternative Minimum Tax and You – Part 2 – I will address the AMT as it pertains to businesses.
Bruce – Your Host at The Tax Nook
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