AMT Exemption

IRS Statistics Show the Alternative Minimum Tax Decreasing – What Gives?

Saturday, January 14th, 2012 | Print This Post Print This Post | Email This Post Email This Post

Periodically the IRS publishes what it calls its Statistics of Income Bulletin.  This document reports data that has been compiled from all of the tax returns filed for the previous year, including data on the Alternative Minimum Tax.  This year’s report shows that, for the first time after six straight years of the AMT increasing, the amount of AMT paid and the number of taxpayers paying it decreased from the previous year.  Are we finally seeing some needed relief from this burden?  Hardly; rather it is just another result of the terrible economy we find ourselves in.

 

Fall 2011 SOI Bulletin

 

The Fall 2011 Bulletin includes statistics for tax returns filed in 2010 for the tax year 2009.  For this period a total of 142.5 million individual income tax returns were filed, 3.8 million of which were Alternative Minimum Tax payers paying a total of $22.6 billion of AMT.  These figures represent a decline from the previous year, during which 3.9 million individuals paid the AMT in the total amount of $25.7 billion.  For tax year 2009 the average AMT paid was $5,900, compared to $6,500 for the previous year.

 

Who are the AMT payers?

 

The Bulletin breaks down the makeup of AMT payers by level of adjusted gross income (AGI).  Even with the decline, this data shows that the distribution stayed essentially the same as the prior year, with 24% of AMT payers being those in the $100-200,000 AGI range and the majority – 63% – being in the $200-500,000 range.  So many of those well below what President Obama considers “the rich” are stuck paying this tax that originally was designed to hit only the true wealthy.

 

Why did the AMT burden drop?

 

The explanation for the decrease in number of AMT payers and total dollars of Alternative Minimum Tax paid is not the result of any change in our government’s tax policy, unfortunately, but rather is explained simply by the current economic downturn.  Specifically, as incomes decrease individuals are having less of those items that trigger the AMT.  This applies both on the deduction side of the Alternative Minimum Tax as well as on the income side.

 

- Itemized deductions, in particular the deduction for state and local taxes

 

The amount of itemized deductions taken by individuals decreased from 2008 to 2009.  The one most important to Alternative Minimum Tax payers, the deduction for state and local income taxes and property taxes, itself decreased 7.5 percent.  As all AMT payers know, the more state and local taxes paid, the greater the Alternative Minimum Tax burden.  It follows logically, therefore, that lower taxes paid potentially means a lower AMT burden.  This won’t necessarily apply to all taxpayers, particularly those whose state legislators saw fit to increase taxes such as Illinois, but in general this result follows.

 

- Capital gains and dividend income

 

Capital gains and dividends are taxed at the same low rate both for the Regular Tax as well as the Alternative Minimum Tax.  However, the more of these items a taxpayer has the more the taxpayer’s AMT exemption will be phased out and the correspondingly higher his Alternative Minimum Tax burden will be.  It follows, therefore, that the worse the stock market does, and the more that companies cut back on their dividends, the less that individuals will see this impact on their AMT exemptions.  Again, this won’t necessarily apply across the board, but it generally explains the result.

 

What should AMT payers do?

 

Planning to minimize the Alternative Minimum Tax is the same regardless of any changes in a taxpayer’s individual position.  If an individual was on the cusp and the current state of the economy dropped him out of the AMT, there are opportunities to time some of his income and deductions to take advantage of this.  For example, folks not in the AMT may want to accelerate the deduction of property taxes to take advantage of the opportunity to get a Regular Tax benefit that is not available once back in the AMT.  But caution needs to be exercised as a slight change in facts can throw the individual right back into the AMT again.  So planning still is, and always will be, the key.

 

As taxpayers get ready to undertake preparation of their 2011 taxes, this information will be very useful in thinking about 2012 planning.  Certainly the 3.8 million still stuck in the AMT need to do this, as well as the 100,000 that dropped out of the AMT last year.

 

Posted in AMT Exemption, AMT Items, AMT Planning in General, Capital gains & Dividends, State Income & Other Taxes | No Comments »

Year-End Tax Extenders – Where’s The Patch?

Sunday, December 11th, 2011 | Print This Post Print This Post | Email This Post Email This Post

Every year at about this time Congress starts thinking about what tax laws will expire on December 31, and what it really needs to be doing about these.  Of the 65 various tax provisions that will expire, one of the big ones is the annual “Patch” for the Alternative Minimum Tax.  Without the Patch, nearly 30 million new taxpayers will wake up on New Year’s Day with a lot more than the usual hangover, and the 4 million already in the AMT had better get their checkbooks out for the additional taxes they’ll owe.  In addition to this one item, however, there are several other extenders that also can have a direct impact on AMT payers.

 

What is The Patch and what does it mean to AMT payers?

 

The Patch is the annual adjustment to the exemption amount allowed in computing each individual’s AMT.  Using the married filing jointly example, the exemption for 2011 is $74,450.  If the Patch is not enacted for 2012, this amount would drop to $45,000, meaning that the couple’s taxable income subject to the AMT would increase by $29,450 – the difference between these two numbers.  This could mean an additional $8,000 in Alternative Minimum Tax due in 2012!

 

Personal tax credits allowed against the AMT

 

The tax law is replete with what are known as “tax credits.”  A tax credit is distinguished from a tax deduction in that it is a direct reduction of your tax liability instead of a reduction of your taxable income in computing your tax liability.  For example, if you are in the 26% AMT bracket a $100 tax deduction would save you $26 in taxes.  Compare this with a $100 tax credit, which would reduce your taxes by the full $100.  One example of a credit that a taxpayer might be eligible is that allowed for making certain energy-efficient improvements to one’s personal residence.

 

A significant number of tax credits are allowed only to individuals paying the Regular Tax, denying those stuck in the AMT a similar benefit.  On occasion, however, Congress has seen fit to extend these benefits to AMT payers, but only for one year at a time.  A number of these types of credits are on the tax extenders list.

 

State and local sales tax deduction

 

For individuals living in a state with no personal income tax, Congress has on occasion allowed these folks a deduction for state and local sales tax paid.  This deduction currently is on the list of extenders that are needed in 2012.  Just like other state and local taxes – property taxes and income taxes, for example – a deduction for state sales tax is allowed for Regular Tax purposes but not for Alternative Minimum Tax payers.  Thus, for individuals in these states the extension – or not – of this as an allowable deduction can have a direct impact on their AMT paid.

 

Small business stock

 

Gains from the sale of qualifying “small business stock” may not need to be fully reported for purposes of the Regular Tax.  For the AMT, however, a portion of the gain needs to be added back into taxable income.  Some of the special rules that apply to small business stock are on one-year extenders, so an AMT payer with this item will be affected by these extenders.

 

Percentage depletion

 

For investors and operators in the oil and gas business, the use of percentage depletion can trigger the AMT.  Percentage depletion computations are complex, with several limitations imposed in the various steps of the calculations.  The extension of one of these items, knows as the 100%-of-net-income limitation, could have a direct impact on affected AMT payers.

 

Conclusion

 

Politics being politics, one never knows with any certainty what Congress is going to do or when they are going to do it.  Historically, however, these extenders – including The Patch – have been enacted, although more often than not well past the deadline but on a retroactive basis.  Readers are advised to keep an eye on developments on this important topic.

Posted in AMT credits, AMT Exemption, AMT Items, Credits Allowable, Legislation/tax law changes, State Income & Other Taxes, The "patch" | No Comments »

Year-End Tax Planning – Should You Accelerate or Defer Income to Minimize Your Alternative Minimum Tax?

Saturday, November 19th, 2011 | Print This Post Print This Post | Email This Post Email This Post

In connection with year-end tax planning, much has been written about accelerating or deferring deductions.  The sometimes-overlooked question of accelerating or deferring income deserves just as much attention, especially for those in the Alternative Minimum Tax.  This article will look at what needs to be considered in planning around income recognition, including a summary of the different types of income to which this planning can apply.

 

What happens with the AMT calculation when one’s income level changes?

 

Tax brackets for the Alternative Minimum Tax are progressive, as are those of the Regular Tax.  What this means in simple terms is that additional amounts of income are taxed at a higher rate than the tax rates that apply to the lower levels of income.  The Regular Tax has six brackets, ranging from 10% to 35%, while the AMT has just two – 26% and 28%.  As will be explained below, however, there are other adjustments in computing taxable income that actually can make these stated tax brackets significantly higher.

 

What are the real AMT brackets?

 

In calculating the Alternative Minimum Tax, an individual is allowed to subtract an exemption amount from what otherwise would be taxable income.  This exemption amount is $74,450 for a married couple in 2011.  As has been discussed in previous articles, however, the exemption is phased out as a taxpayer’s income increases.  This phaseout has the direct  effect, therefore, of increasing the effective AMT tax rates for individuals who find themselves in this phaseout range.

 

For 2011, for the married couple, the phaseout begins at $150,000 and doesn’t stop until their income exceeds $440,000.  Within this range, each incremental $100 of income will result in a loss of $25 of the AMT exemption.  The result is that a 28% Alternative Minimum Tax bracket is increased by a factor of 25%, resulting in an effective AMT tax bracket of 35%!

 

What does all this mean for planning?

 

Knowing one’s effective tax bracket is the only way to do proper AMT planning.  It can be a costly mistake to deliberately accelerating income, thinking one is in an Alternative Minimum Tax bracket lower than the Regular Tax bracket, only to find out this actually is not the case.  Many year-end tax planning articles routinely suggest that people in the AMT do exactly this, but without knowing what your effective AMT tax rate is it could instead turn out to be a costly mistake.

 

What types of income can be accelerated or deferred?

 

The answer to this question will depend on each individual’s situation- i.e., whether the person is employed or self-employed, what kind of investments the person has, etc.  Discussed below is a brief overview of some of the types of income that an individual may be able to accelerate or defer at year-end.

 

-  Employee compensation such as bonuses and stock options

 

Some employers allow employees the choice of taking their bonuses currently or deferring them to a future year.  In addition, employees may be granted stock options, and the timing of when these options are exercised is entirely up to the employee – they can be exercised just as easily in December as they can in January.  If the employee has what are known as nonqualified stock options, taxable income will be recognized immediately on the date of exercise – both for the AMT as well as Regular Tax purposes.  If the options are qualified options (these are more commonly known as incentive stock options, or ISOs), there is no taxable income on the date of exercise for Regular Tax purposes, but there is for the Alternative Minimum Tax.

 

-  Business income from self-employment, LLCs or partnerships

 

A business usually has some degree of control at year-end over its net income for that last month of the tax year.  For example, a cash-method business could pay outstanding bills in December to reduce income, or wait to pay them in January, which would directly affect the amount of income reported on the business owner’s tax return.  The business also could hold off from sending out certain bills out towards the end of the year, thus postponing income into the following year.

 

-  Investment income

 

Here are some acceleration or deferral thoughts on a few types of investments:

 

Capital gains – an individual has complete control over the timing of any sales of investments, so capital gains easily could be recognized this year or next.

 

Rental income – a landlord might ask for the rent check that is due on January 1st to be paid a few days early.

 

Interest and dividends – as a longer-term strategy, an individual could shift in or out of bonds and/or dividend-paying stocks to affect the amount of interest and dividend income received on a current basis.

 

Conclusion

 

Knowing what tax bracket the taxpayer is in is critical to any tax planning, but especially so for individuals in the Alternative Minimum Tax.  The only way to minimize the AMT is to take a little time as we approach year-end to look at the options available in terms of what income might be moved between 2011 and 2012, and then to figure out which of these choices will result in the lowest tax burden.  With the holiday season keeping everybody pretty busy, it’s never too soon to start doing at this!

Posted in AMT Exemption, AMT Items, AMT Planning in General, Calculation of the AMT, Capital gains & Dividends, Incentive Stock Options Exercised, Investor, Self Employed, Type of Taxpayer | No Comments »

Year-end Tax Planning Newsletter Focusing on the Alternative Minimum Tax – October

Saturday, November 12th, 2011 | Print This Post Print This Post | Email This Post Email This Post

Oct2011-Newsletter

Posted in AMT Exemption, AMT Planning in General, Calculation of the AMT | No Comments »

IRS Announces 2012 Inflation Adjustments, Once Again Highlighting the Need for Another Alternative Minimum Tax “Patch”

Friday, October 21st, 2011 | Print This Post Print This Post | Email This Post Email This Post

As it does in the fall of every year, the IRS has calculated the effect that inflation has had on the income tax brackets that are used to compute the individual income tax, and it recently has announced what the tax brackets will be for 2012.  These adjustments are required under the tax law, but they are limited to the Regular Tax brackets only – no similar adjustments are made for the Alternative Minimum Tax.  Unless Congress specifically addresses the issue with another AMT Patch, this mismatch will result in approximately 25 million additional taxpayers becoming subject to the AMT in 2012.

 

The Patch

 

The Patch, as it is famously known, is the mechanism used by Congress to offset the failure of the tax law to automatically require an adjustment of the AMT brackets for inflation.  This failure, with the resulting need for the annual Patch, has been going on since 2000, over a decade now.  The reason for the constant one-year fixes, or “patches,” is simple – it has been estimated that a permanent fix would cost in excess of one trillion dollars.  While the one-year fixes in and of themselves are expensive, there is simply no way that Congress could ever find enough money to do a permanent fix in the absence of a complete overhaul of our U.S. tax system.

 

The AMT exemption

 

The actual Patch mechanism is the making of an adjustment to the Alternative Minimum Tax exemption amount.  For a married couple filing a joint return, for 2011 the exemption amount is $74,450 (other filing statuses have different exemption amounts).  What this means is that taxable income for AMT purposes will be $74,450 less than what it otherwise would be, after increasing Regular Tax taxable income for the numerous AMT adjustment items.  The purpose of this is to ensure that folks at lower levels of taxable income, and folks who don’t have very many AMT items, are not caught in the AMT net.

 

What happens if there is no Patch

 

If Congress does not enact another Patch, the exemption amount will drop significantly, all the way back to what it was in 2000.  For a married couple, this would equate to an exemption of only $45,000 – 40 percent less than what it is today.  This substantial drop in the exemption would result in the 25 million additional AMT payers mentioned above.

 

When will Congress act?

 

Although one can never predict when Congress will get around to doing things, as we have seen time and time again Congress does tend to postpone dealing with difficult issues until the very last moment.  Thus, even though these 25 million individuals technically become AMT payers on January 1, 2012, the average time it has taken Congress to enact the Patch is seven months into the tax year.  Thus, if they followed this average we won’t know until July, 2012 what the revised exemption amount is.  But don’t’ assume July – twice during the past decade it has actually taken Congress until December to enact the Patch.

 

The “Patch watch”

 

Congress knows what it needs to do.  All that can be done is to wait, and watch and monitor the goings-on in Washington.  Future articles will be doing exactly this, and reporting on any developments when they occur.

Posted in AMT Exemption, Calculation of the AMT, Legislation/tax law changes, The "patch" | No Comments »

IRS Releases 2011 Version of Form 6251 – Alternative Minimum Tax-Individuals, a Reminder That It’s Time to Start Thinking about Year-End Tax Planning

Saturday, September 24th, 2011 | Print This Post Print This Post | Email This Post Email This Post

The IRS recently released its 2011 version of the Form 6251 – Alternative Minimum Tax – Individuals.  With year-end only a few months away, this serves as a timely reminder that anyone stuck in the AMT needs to start thinking about the ways they can reduce this burden.  The most effective AMT planning strategies must be implemented by December 31 in order to have any impact on the current year’s taxes.  This article provides a general overview of some of the more important of these planning strategies.

 

AMT exemption amount

 

Late last year Congress once again adjusted the AMT exemption amount for inflation -   for 2011 it is $74,450 for married couples filing a joint income tax return and $48,450 for singles.  While Congress hasn’t even started thinking about the “patch” that will be needed again on January 1, 2012, we can guess that at some point that will be taken care of.

 

Phaseout of the exemption

 

For taxpayers whose incomes reach a certain level, the exemption is gradually phased out.  This phaseout is at the rate of $1 of exemption lost for every $4 of income above the threshold.  For 2011 the threshold for marrieds filing jointly is $150,000, and for singles it is $112,500.  If a couple’s income is $160,000, for example, the exemption is reduced by $2,500.  If the couple’s taxable income reaches $447,800, the exemption is zero.

 

Capital gains and dividends

 

While capital losses may be more typical these days due to the stock market’s wild gyrations, it’s important to note the AMT impact that results from capital gains as well as dividend income.  These sources of income are taxed at the same 15% rate for both the AMT as well as the Regular Tax, but there is a direct impact on an individual’s AMT burden because of the exemption phaseout discussed above.  For example, a $10,000 capital gain by itself can result in $700 of AMT being paid (loss of $2,500 of exemption times the marginal AMT rate of 28%).

 

Itemized deductions – state and local income taxes

 

The one item that affects the greatest majority of folks stuck in the Alternative Minimum Tax is the itemized deduction for state and local income taxes.  While allowable for the Regular Tax, this deduction is disallowed in its entirely for the AMT.  For taxpayers who expect to be in the AMT for 2011, serious consideration should be given to postponing payment of some portion of these taxes into 2012.  If the taxpayer is not in the AMT in 2012, real tax dollars can be saved that otherwise would have been “wasted” by not ding this basic planning.

 

Itemized deductions – property taxes

 

The next biggest item in terms of AMT exposure is property taxes which, similar to state and local income taxes, are not deductible in computing the Alternative Minimum Tax.  Many taxpayers receive their property tax bills in the fall, with a period of months before the taxes are actually due.  Just as with the state income tax planning mentioned above, taxpayers currently in the AMT might be better off pushing the payment of these property taxes into 2012.

 

Other AMT items

 

There are quite a few other AMT items in addition to those mentioned above.  Some of these items are deductions from income that are allowed for Regular Tax purposes but not allowed for the AMT, while others are certain types of income that are treated differently for the Alternative Minimum Tax.  The Form 6251, available on the IRS’ web site, serves as a list of all of these items.  Taking a look at last year’s tax return serves as a great starting point to see which items are likely to affect the taxpayer again this year.

 

The value of planning

 

The average amount of AMT paid by each taxpayer caught in its tentacles is over $5,000.  Just a little bit of time spent on basic tax planning can result in some significant amounts being saved!

Posted in AMT Exemption, AMT Items, AMT Planning in General, Capital gains & Dividends, State Income & Other Taxes, Uncategorized | No Comments »

Index the Individual Alternative Minimum Tax Amounts for Inflation

Monday, July 4th, 2011 | Print This Post Print This Post | Email This Post Email This Post

More from the Joint Committee on Taxation – just-released report “Description of Revenue Provisions Contained in the President’s Fiscal Year 2012 Budget Proposal.” This massive 647-page report contains a proposal for a permanent Alternative Minimum Tax “patch,” as set forth below.

 

Present Law

 

Present law imposes an alternative minimum tax (“AMT”) on individuals. The AMT is

the amount by which the tentative minimum tax exceeds the regular income tax. An individual’s tentative minimum tax is the sum of (1) 26 percent of the first $175,000 ($87,500 in the case of a married individual filing a separate return) of the excess of alternative minimum taxable income (“AMTI”) over the AMT exemption amount and (2) 28 percent of the remaining excess. The maximum tax rates on net capital gain and dividends used in computing the regular tax are used in computing the tentative minimum tax. AMTI is the individual’s taxable income adjusted to take account of specified preferences and adjustments.

 

The exemption amounts are: (1) $74,450 ($45,000 in taxable years beginning after 2011)

in the case of married individuals filing a joint return and surviving spouses; (2) $48,450

($33,750 in taxable years beginning after 2011) in the case of other unmarried individuals; (3) $37,225 ($22,500 in taxable years beginning after 2011) in the case of married individuals filing separate returns; and (4) $22,500 in the case of an estate or trust. The exemption amounts are phased out by an amount equal to 25 percent of the amount by which the individual’s AMTI exceeds (1) $150,000 in the case of married individuals filing a joint return and surviving spouses, (2) $112,500 in the case of other unmarried individuals, and (3) $75,000 in the case of married individuals filing separate returns or an estate or a trust. These amounts are not indexed for inflation.

 

Present law provides for certain nonrefundable personal tax credits. These credit include

the dependent care credit, the credit for the elderly and disabled, the adoption credit, the child credit, the credit for interest on certain home mortgages, the Hope Scholarship and Lifetime Learning credits, the credit for savers, the credit for certain nonbusiness energy property, the credit for residential energy efficient property, the credit for certain plug-in electric vehicles, the credit for alternative motor vehicles, the credit for new qualified plug-in electric drive motor vehicles, and the D.C. first-time homebuyer credit.

 

For taxable years beginning before 2012, the nonrefundable personal credits are allowed

to the extent of the full amount of the individual’s regular tax and alternative minimum tax.  For taxable years beginning after 2011, the nonrefundable personal credits (other than the adoption credit, the child credit, the Hope Scholarship credit (for taxable years beginning after 2012), the credit for savers, the credit for residential energy efficient property, the credit for certain plug-in electric vehicles, the credit for alternative motor vehicles, and the credit for new qualified plug-in electric drive motor vehicles) are allowed only to the extent that the individual’s regular income tax liability exceeds the individual’s tentative minimum tax, determined without regard to the minimum tax foreign tax credit. The adoption credit, the child credit, the Hope Scholarship credit (for taxable years beginning before 2013), the credit for savers, the credit for residential energy efficient property, the credit certain plug-in electric vehicles, the credit for alternative motor vehicles, and the credit for new qualified plug-in electric drive motor vehicles are allowed to the full extent of the individual’s regular tax and alternative minimum tax.1640

 

Description of Proposal

The proposal provides that the individual AMT exemption amounts, including the

thresholds for the phaseout of the exemption amounts, are indexed for inflation from the levels in effect for 2011. The proposal indexes the threshold amounts for the beginning of the 28-percent bracket.  The proposal allows an individual to offset the entire regular tax liability and alternative minimum tax liability by the nonrefundable personal credits.

 

Effective date.–The proposal is effective for taxable years beginning after 2011.

Analysis

 

Allowing the nonrefundable personal credits to offset the regular tax and alternative

minimum tax, and increasing the exemption amounts, will substantially reduce the number of taxpayers affected by the AMT. In addition to the reduction in tax liability as a result of this change, there will be significant simplification benefits. Substantially fewer taxpayers will need to complete the alternative minimum tax form (Form 6251), and the forms and worksheets relating to the various credits can be simplified.

 

By permanently establishing the AMT exemption levels and ability to take nonrefundable

credits against the AMT, the proposal provides greater certainty for taxpayers as to their tax obligation resulting from the AMT, in comparison to the practice over the past years of annually adjusting the exemption levels to prevent their reversion to the levels in effect prior to EGTRRA.  Additionally, by indexing the AMT system for inflation, as is done in the regular tax system, the proposal prevents tax increases in real terms for the portion of one’s income growth that merely accounts for inflationary growth. By doing so, the proposal substantially slows the rate of growth in the number of taxpayers subject to the AMT over time.

 

A number of analysts argue that the proposal does not go far enough, advocating instead

the abolition of the AMT. Their argument rests on the observation that the AMT system has outlived its original purpose of requiring taxpayers engaged in substantial sheltering of income to pay at least some minimum tax. Instead, taxpayers today are mainly ensnared by the AMT as a result of their income level, payment of state and local taxes, and presence of dependents. Such analysts argue that requiring such taxpayers to calculate their liability two ways is needlessly complex and serves no discernible policy objective that the regular tax alone couldn’t provide.

 

1640 The rule applicable to the child credit after 2012 is subject to the EGTRRA sunset. The adoption credit

is refundable in 2011 and beginning in 2012 is nonrefundable and treated in the same manner as the child credit.

 

Posted in AMT credits, AMT Exemption, Legislation/tax law changes, The "patch" | No Comments »

Tax Court Denies Challenge to the Alternative Minimum Tax, Revealing Costly AMT Taxpayer Errors

Sunday, May 15th, 2011 | Print This Post Print This Post | Email This Post Email This Post

On occasion a frustrated taxpayer will go to Tax Court in an attempt to convince a judge that the Alternative Minimum Tax was never intended to apply to them.  As in the case of Fritz v. Commissioner, however, no sympathy is ever found there – if the calculations are done correctly the Court simply confirms that the tax is owed.  The facts in these cases present interesting lessons, however, because they reveal both the terrible feeling of frustration when getting blindsided by the AMT as well as the simple, yet missed, planning opportunities that could have allowed many of these folks to avoid paying the AMT.

 

Facts of the case

 

Mr. and Mrs. Fritz filed their tax return without attaching Form 6251, “Alternative Minimum Tax – Individuals.”  They promptly received a notice from the IRS informing them that they owed exactly $7,007 more in AMT.  The Fritz’s tax return was relatively simple – $329,000 of total income, the majority of which – $283,000 – was long-term capital gain and qualifying dividends.  The Fritzes took the standard deduction, apparently because this was greater than their itemized deductions, as well as the deduction for their personal exemptions.

 

Alternative Minimum Tax problem

 

Two AMT issues caused the Fritz’s Alternative Minimum Tax problem.

 

Loss of the standard deduction and the deduction for personal exemptions

 

As has been discussed in many previous articles, under the AMT the standard deduction is disallowed in total, as are the deductions for personal exemptions.  Because of this, Alternative Minimum Taxable Income (AMTI) is always higher than Regular Tax taxable income by these amounts.  For 2011, the standard deduction for a married couple filing jointly is $11,600, and each personal exemption is $3,700.  In a case like the Fritzes, their AMTI for the current year would be $19,000 higher.

 

Loss of the AMT Exemption due to the large capital gain

 

When a married couple’s AMTI exceeds $150,000 the AMT exemption begins to be phased out.  The exemption amount for 2011 is $74,450, but this is phased out at the rate of $1 of exemption for every $4 of AMTI in excess of $150,000.  In the Fritz’ situation, they would lose $44,672 allowing them an AMT exemption amount of only $29,778.

 

The Fritz’ argument

 

The argument made to the Tax Court by the Fritzes was that capital gains and qualifying dividends should be taxed at the 15 percent tax rate, as specified in the tax law for both the AMT as well as for the Regular Tax.  By operation of the AMT calculations, they alleged, their effective tax rate on this income actually was higher than this.

 

The Tax Court’s answer

 

The Tax Court judge was direct in his response: “Petitioner’s position in this case misses the point.  In reality, the tax on the capital gains was limited to 15 percent and the ‘additional tax’ was attributable to the elimination of preferences.”  Judgment in favor of the IRS.

 

Planning opportunities the Fritzes missed

 

There are several things the Fritzes could have done to reduce, and likely eliminate, their Alternative Minimum Tax.

 

Itemizing deductions instead of taking the standard deduction – If the Fritzes had home mortgage interest, or if they had made any charitable contributions, they could have reduced their AMT by itemizing deductions instead of taking the standard deduction.  This, unfortunately, is a common error for AMT payers.  If they had had, for example, just $1,000 in interest or contributions, they would have directly reduced their Alternative Minimum Tax by $280.  They weren’t required to take the standard deduction; they did it because it was larger than their itemized deductions, and they just didn’t think about the AMT.

 

Spread the capital gain over two or more years – The timing of when to sell securities and realize capital gains is entirely within the control of a taxpayer.  Not spreading their very large gain of $246,000 over just two years was a costly mistake on the part of the Fritzes.  If they had instead recognized half of their capital gain in the current year and pushed the other half to the following year, they would have lost over $30,000 less of their AMT exemption, most likely removing them entirely from the AMT!

 

Conclusion

 

As the Fritzes learned the hard way, paying the Alternative Minimum Tax is a penalty that often can be avoided with just a little awareness of the AMT.  Had Mr. & Mrs. Fritz done this, they would have $7,000 more in their bank account today instead of having to put this amount in the mail to the US Treasury.  Lesson learned the hard way!

 

Posted in AMT Exemption, AMT Planning in General, Calculation of the AMT, Capital gains & Dividends, Personal Exemptions, Standard Deduction | No Comments »

Exercising Employee Stock Options – Beware of the Alternative Minimum Tax

Saturday, April 2nd, 2011 | Print This Post Print This Post | Email This Post Email This Post

With the stock market having nearly doubled over the past two years, many individuals holding stock options that they received from their employers are giving serious consideration to cashing out the value in these options.  This article discusses the two principal types of options and explains the different AMT issues associated with each.

 

Types of stock options

 

For tax purposes there are two types of stock options – “qualified” and “nonqualified.”  The official term for a qualified option is Incentive Stock Option, commonly referred to as an “ISO.”  Each employer has the discretion, through the design of its plan, as to which type of option it grants to the employee, and it is not uncommon for some employees to have both types.  It is important to note here that it is the responsibility of the individual to understand what he has.

 

Stock option essentials

 

A stock option, like any other option, is a contract giving one person the right to buy property from another person at a predetermined price.  If the underlying property (stock) increases in value, the value of the option correspondingly increases.  If the value of the stock decreases, the option has no value.  Options generally have a fixed term – five to ten years for stock options is common, so the employee must act within this period or the option will lapse.

 

Example – an employee is granted an option to buy 1,000 shares of his employer’s stock at today’s value of $50.  If the stock increases to $60 before the option lapses, the employee can exercise the option, effectively buying the shares from the employer at a discount and, in this example, realizing a $10,000 gain.  To alleviate the hardship of asking the employee to write a check for the $50,000 exercise price, employers commonly arrange with a broker to allow what is referred to as a “cashless” exercise involving a same day sale.  In this situation, on the date of exercise the broker sells an equivalent number of shares, and then sends the employer the $50,000 along with enough to cover the tax withholding requirements.  Then, at the close of the market’s three-day settlement period, the net amount ($10,000 less taxes) is credited to the employee’s account.

 

Tax results from option exercise

 

Nonqualified option – on the date of exercise the $10,000 in the above example is taxable income.  This is ordinary income, not capital gain, just as if it were part of the employee’s salaries and wages.  The $10,000 will be included in taxable income reported in the employee’s W-2 at the end of the year.

 

ISO (qualified option) – The $10,000 will not be taxed as income on the date of exercise.  Instead, it is a tax preference item for purposes of the AMT, meaning that Alternative Minimum Taxable Income will be higher than the employee’s Regular Tax taxable income by $10,000.  The number in this example is relatively small, but if the preference item from an ISO exercise is large enough the employee easily can find himself stuck in the AMT.  If the individual already is in the AMT, the hit from an ISO exercise will make it just that much more painful.

 

Tax planning for option exercises

 

The exercise of a nonqualified option does not have any direct AMT consequences.  As an individual’s taxable income increases, however, the Alternative Minimum Tax exemption is phased out, so testing for the impact of this is important before exercising even a nonqualified option.

 

Especially critical, however, is tax planning before doing an ISO exercise.  In order to exercise an ISO without triggering the Alternative Minimum Tax, the individual has to do the tax calculation under alternative assumptions as to the size of the exercise, as well as consider doing the exercise partially in one year and partially in the next.  By doing this it certainly is possible to minimize the impact of an ISO exercise.  Note also that the employee has a period of time after the exercise within which a sale of the stock will constitute a “disqualifying disposition,” thus negating the AMT effect and retroactively treating the transaction as if it were instead a nonqualifying option.

 

Summary

 

The underlying investment decision as to the right time to cash out of employee stock options must, of course, must be the individual’s primary focus, but if that exercise will bring along with it a big AMT hit taxes need to be considered in deciding how many options to exercise and in what year they are exercised.  That nice chunk of extra income the employee thinks he is getting can be seriously eroded by improper tax planning.

 

Posted in AMT Exemption, AMT Planning in General, Incentive Stock Options Exercised, Salaried, Type of Taxpayer | No Comments »

I Am Retired – Does the AMT Apply to Me?

Thursday, March 17th, 2011 | Print This Post Print This Post | Email This Post Email This Post

Of all the different types of AMT taxpayers, retirees typically are the most surprised when they find themselves stuck in the Alternative Minimum Tax.  Unfortunately, there is no “age exemption” for the AMT – an individual could reach 100 and still be paying it, depending on that person’s level and types of income and tax deductions.  In certain cases, the AMT may even hit a retiree harder than a person still working.  With a little understanding of the issues and some advance planning, retirees may actually be in a better position than others to do something about the AMT.

 

There’s a great story that Eric Solomon, Assistant Secretary of the U.S. Treasury for Tax Policy during the Bush administration, used to tell.  His father had received a letter from the IRS stating that his 2004 tax return could not be processed because he had not computed his Alternative Minimum Tax. “My dad said, ‘I’m 82. I don’t pay the AMT,’” Solomon would recall. Unfortunately, no such octogenarian exemption exists, but Solomon said he had to spend three hours on the phone with his dad working through the Form 6251.

 

This article will address both income issues associated with retirees and the AMT as well as deduction issues.

 

Income issues

 

Retirement plan distributions

 

Individuals have many choices as to how they can take distributions from their retirement plans, whether these plans are in the form of pensions or 401(k)-type plans.  A lump-sum distribution, or some other accelerated form of distribution, more likely would trigger the AMT than choosing a lifetime annuity.  This is because the higher one’s income is in any one year the more likely the AMT exemption is phased out, in turn meaning the more likely the individual is to be in the Alternative Minimum Tax.

 

Stock options- nonqualified

 

Many mid- to upper-level employees who work for a corporation, typically a publicly-traded corporation, receive “nonqualified” stock options as part of their compensation packages.  Many of these option plans allow the individual a certain period of time after retirement to exercise these options.  Similar to the point made above with respect to retirement plans, a retiree must consider the AMT impact when deciding when to exercise these options and how much income will be generated.

 

Stock options – Incentive Stock Options

 

If an individual has Incentive Stock Options, the exercise of these in one year can almost guarantee paying the Alternative Minimum Tax.  This is because the difference between the value of the stock on the date of exercise and the option price is a direct AMT preference item – unlike the indirect effect the exercise of nonqualified stock options can have as discussed above.

 

Capital gains

 

Retirees on occasion may have capital gains that are disproportionately large in comparison to the rest of their income.  These gains may result from distributions from mutual funds, over which the individual has no direct control, or from an effort to diversify an investment that is too concentrated in one stock, or from any number of reasons.  These sudden bumps in income can cause the retiree to lose a portion of his AMT exemption, resulting in a problem similar to those discussed above.

 

Deduction issues

 

Standard deduction

 

A taxpayer may elect to take the “standard deduction” in lieu of itemizing deductions.  The amount of the deduction varies by filing status, but for a couple filing jointly it is $11,600 for 2011.  Since no standard deduction is allowed for the AMT, Alternative Minimum Taxable income – the amount on which the AMT is calculated – will be $11,600 higher than Regular Tax taxable income.  Add to this the extra $2,300 exemption for folks age 65 and over and one can see why more and more retirees are being pulled into the AMT.  Note that an extra amount also is allowed in cases of blindness, further exacerbating the problem for these individuals.

 

Property taxes and state income taxes – changes in state of residence

 

An individual who itemizes deductions generally will get a Regular Tax benefit for property taxes and state income taxes, as well as certain other state and local taxes.  None of these taxes is allowable as a deduction in computing the Alternative Minimum Tax.  Accordingly, like the standard deduction issue discussed above, taxable income on which the AMT is calculated will be higher than Regular Tax taxable income.  If a change in state of residence at retirement is contemplated, it is important to plan for the AMT effects.  Moving from a high state and local tax jurisdiction to a state without income tax like Florida, for example, could mean falling out of the AMT along with a corresponding opportunity to move income, or deductions, from one year to the other to minimize the AMT.

 

Summary

 

A sudden change in one’s income position, as typically happens in the case of retirement, can present significant Alternative Minimum Tax planning opportunities.  Deductions that would be lost in an AMT year may be shifted to a Regular Tax year, and income might be taxed at a lower rate in one year versus the other.  These principles apply to all future retirement years; not just the year of transition from employment to retirement.  While often overlooked, taxes, especially the Alternative Minimum Tax, are a very important part of planning for retirement.

 

Posted in AMT Exemption, AMT Planning in General, Calculation of the AMT, Capital gains & Dividends, Incentive Stock Options Exercised, Retiree, Standard Deduction, State Income & Other Taxes, Type of Taxpayer | 1 Comment »

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