With few exceptions, when the Alternative Minimum Tax is paid it is money out the door – gone forever. No surprise here since this is the way taxes work. What is a surprise to many folks, however, is that a portion of the AMT paid in one year may instead simply be a prepayment of taxes – referred to as a “credit” – that may be available as a refund in a future year. Understanding which AMT items generate this future credit and which don’t can result in additional tax savings.
AMT items that are “exclusion items”
There are many different kinds of deductions allowed in computing taxable income. For the AMT, a distinction is made between those that are “exclusion” items and those that are not. Exclusion items are those that are either deductible or not in the year paid – they have no impact on future years. Common examples of these are the various itemized deductions that are allowed for the Regular Tax but not for the Alternative Minimum Tax.
AMT items that are not exclusion items
A distinction is made between exclusion items, and those AMT items that affect only the timing of when a deduction is taken. The most common example of this is Depreciation. A deduction for depreciation of business or certain investment assets is allowed both for the Regular Tax as well as the Alternative Minimum Tax, but if a taxpayer chooses an accelerated form of depreciation for Regular Tax purposes he is getting a disproportionately larger deduction in the early years of the asset’s life. The AMT says “no” to this – the acceleration needs to be slowed down a little.
AMT items that are not exclusion items – specific examples
Below is a list of the Alternative Minimum Tax items that are not exclusion items, and, thus, to the extent a taxpayer is paying the AMT as a result of any of these items, that portion of the AMT is eligible to be taken as a credit against future taxes owed by the individual (line references shown are to the 2010 Form 6251):
Investment interest expense – line 8
AMT net operating loss deduction – line 11
Incentive stock options – line 14
Estates and trusts – line 15
Electing large partnerships – line 16
Disposition of property – line 17
Depreciation – line 18
Passive activities – line 19
Loss limitations – line 20
Circulation costs – line 21
Long-term contracts – line 22
Mining costs – line 23
R & D costs – line 24
Certain installment sales – line 25
Intangible drilling costs – line 26
Form used to report the credit
IRS Form 8801 is the tax form used to calculate the amount of credit that may be taken in the current year for prior years’ AMT paid. This form pulls data from the prior year’s Form 6251, and uses it to compute how much of the AMT paid in the prior year is attributable to exclusion items. The difference, if any, between the total AMT paid in the prior year and this recomputed amount is the amount of AMT available as a credit in the current year.
Credit is taken against the Regular Tax
The AMT credit carryover may be taken as a reduction of the current year’s Regular Tax. Thus, if the taxpayer is in the AMT again, the credit can’t yet be used, but it will accumulate and be carried to a future year when the Regular Tax is paid. Under a special rule, however, if after three years the credit carryover hasn’t been used, 50% of it may be used against the taxpayer’s then-current year AMT.
Case study – Sarah Palin’s tax return
During the 2008 Presidential campaign, as is common practice the candidates for office released copies of their tax returns. The tax return filed by Sarah Palin and her husband for 2006 included a Form 8801, which was used to test whether there was an AMT credit carryover from prior years. While the prior years’ returns were not released, it was interesting to note that Todd Palin was self-employed in several businesses that utilized vehicles and equipment that were depreciable for tax purposes. Because these assets were depreciated using the most accelerated method possible, the AMT had been paid by them in prior years.
Alternative Minimum Tax payers are doing a real disservice to themselves if they fail to test for the AMT credit carryover each year. Depending on the types of AMT items a taxpayer has, and their relative sizes, taxpayers may find a pleasant surprise in the form of a refund of prior year AMT paid!