Misc Deductions 2-percent Floor

I Am an Investor – Does the AMT Apply to Me?

Friday, March 4th, 2011 | Print This Post | Email This Post

Every taxpayer with an investment portfolio of any size definitely needs to be concerned about the Alternative Minimum Tax. Certain types of investments, and the income earned on those investments, are likely to trigger the AMT. Most investors also have expenses associated with managing these portfolios, and certain of these expenses also can have an AMT impact.

It should be noted that only investments outside of qualified retirement plans – e.g., those investments not in a 401(k), an IRA or an employer’s retirement plan – are affected by the AMT, so it is these investments that are the focus of this article.

Investment income

Municipal bonds, in particular Private Activity Bonds

Interest earned on municipal bonds is exempt from the Regular Tax. For the Alternative Minimum Tax, however, certain municipal bonds – those labeled “private activity bonds”- are subject to tax. These types of bonds are used to support “private activities,” an example of which would be a local government’s development of an industrial park as an inducement for companies to locate in the area.

The concern to the investor is the negative impact that being subject to the AMT has on the bond’s effective yield. For example, a municipal bond fund in today’s market may be yielding in excess of 4 percent, but if private activity bonds are a part of that fund’s portfolio, more than a quarter of the yield on this part can be lost due to the AMT. That 4 percent quickly drops to a net-after-tax 3 percent yield!

Partnership investments

For an individual investing in a partnership, after the close of the year a tax form known as a “K-1” will be received. Because the partnership is a pass-through entity for tax purposes, this form tells each partner what income or losses to report on his or her individual tax return.

On the Form K-1 there also is a box labeled “Alternative Minimum Tax (AMT) Items.” If the partnership itself has any AMT items, they pass through and are reported by the individual partners just as the income or losses are. It is fairly common for investment partnerships to have activities that generate AMT items, so investors should consider inquiring about this when initially evaluating the investment. Here again, the anticipated yield can be reduced significantly if the AMT has to be paid.

Capital gains

Long-term capital gains are a bit of a sleeper issue with regard to the Alternative Minimum Tax. Although officially they are taxed at the same tax rate for purposes of the AMT as they are for the Regular Tax (currently 15 percent), and they are not a specifically-identified AMT item, nonetheless they can have a significant impact on an individual’s Alternative Minimum Tax. The reason for this is the fact that, as taxable income increases, the AMT exemption amount is gradually phased out. Since capital gains are included in taxable income, that 15 percent Regular Tax rate easily creeps closer to a 20 percent rate when figuring the AMT. This is especially important for those folks already in the phaseout income range ($150,000 to $440,000 for marrieds filing jointly; varies by filing status).

Investment expenses

Investment interest expense

If money is borrowed for the purpose of making investments, in general the interest paid on the debt is computed the same for the Alternative Minimum Tax as it is for the Regular Tax. There are two exceptions, however. One is if home equity indebtedness is used to acquire investment property. This type of interest is first disallowed for the AMT because it is not considered “qualified residence interest,” but when used for investing it generally is considered an allowable deduction for the AMT. The other exception is for interest on debt the proceeds of which were used to acquire private activity bonds. Because this interest is disallowed for purposes of the Regular Tax under the rules that disallow interest if loan proceeds are used to acquire municipal bonds, the interest expense related to the private activity bonds is an allowable deductible for the AMT.

Investment interest income

Investment interest expense is an allowable deduction, but only to the extent the taxpayer has investment interest income. For purposes of the AMT, investment income is computed somewhat differently than it is for the Regular Tax. For example, if an individual has private activity bond interest, this is included in AMT investment income because it is taxable for the AMT. Another example applies to taxpayers who have rental properties, where the Regular Tax-AMT differences in computing depreciation will result in a difference in investment income, thus affecting the amount of investment interest expense that may be deducted.

Other investment expenses

Investment-related expenses such as fees paid to an investment advisor, trust fees, safe-deposit box fees, etc. and any other expenses incurred in deriving income may be deducted for the Regular Tax, subject to certain limitations that apply. The AMT allows no deduction for these expenses, however, so this item may factor into an individual’s Alternative Minimum Tax computation.

Summary

Taxpayers with an investment portfolio easily can find themselves caught in a number of traps set by the Alternative Minimum Tax. But as the individual has total control over the investments made, these traps generally can be avoided with a little advance planning. For investors currently stuck in the AMT, a review of the items triggering this tax will allow the individual to consider rearranging the portfolio to lessen this AMT impact. The thing always to keep in mind is the simple fact that it is only the after tax yield that ends up in the individual investor’s bank account!

Posted in AMT Planning in General, Capital gains & Dividends, Investment Interest Expense, Investor, K-1 / All other AMT Items, Misc Deductions 2-percent Floor, Private Activity Bonds, Type of Taxpayer | No Comments »

Fall AMT Planning Series – Miscellaneous Itemized Deductions

Sunday, October 17th, 2010 | Print This Post | Email This Post

It is interesting to note that this category of expenses labeled “job expenses and certain miscellaneous deductions” affects nearly one-third of all taxpayers caught in the Alternative Minimum Tax, but that is the case. This category includes, in addition to job-related expenses that are not reimbursed by the taxpayer’s employer, such other things as tax return preparation fees, investment-related expenses such as fees paid to an investment advisor, trust fees, safe-deposit box fees, and any other expenses that are incurred in connection with earning income that is shown on the tax return.

When calculating the Regular Tax, these types of expenses are deductible, but only if in the aggregate they exceed a certain percentage limitation. The limitation is 2 percent of the taxpayer’s Adjusted Gross Income, or “AGI.” For example, if AGI is $100,000, the taxpayer is allowed a deduction if the total of job-related and miscellaneous expenses exceeds $2,000 – but then only for the amount in excess of the $2,000.

For taxpayers stuck in the Alternative Minimum Tax, however, no deduction is allowed for miscellaneous itemized deductions. This difference between the Regular Tax and the AMT is reported on IRS Form 6251 as one of the many adjustments that must be made in calculating AMT income.

There are several key planning tips here:

First, as with all itemized deductions, miscellaneous expenses may be deducted only in the year paid, whether by cash or by writing out and mailing a check, or actually delivering the check. If a credit card is used, the date the charge is put on the card is the important date, even though the credit card bill will not bepaid until later when the bill is received.

Second, as is the case with other items such as state and local taxes, the key AMT planning step is determining whether the taxpayer has enough control over paying the expense so that he could choose to make it a deduction either in the current year or in the following year.

For example, if a taxpayer filed his 2009 return on the final extended due date of October 15, 2010, he likely would not be receiving the bill from his CPA until November. In this case, if the taxpayer is in the AMT in 2010 but will not be in the AMT in 2011, it makes more sense to pay the bill in January, 2011. So long as the 2 percent threshold is exceeded in 2011, there will be a Federal income tax benefit that otherwise would not be available if the bill were paid in 2010. Depending on the individual’s tax bracket, this savings could be up to 35 percent of the amount of this deductible expense, or even higher if the Bush tax cuts are allowed to expire.

There is nothing fancy about this tax reduction opportunity – it’s just the same basic and easily executed tax planning strategy, just like those discussed in our earlier articles. Estimating your tax situation this year and next – to see if you are in or out of the AMT – and then just paying the bill in the more advantageous year is all there is to it.

Posted in AMT Planning in General, Misc Deductions 2-percent Floor | No Comments »

Top 10 Traps Set by the AMT

Saturday, April 10th, 2010 | Print This Post | Email This Post

Of the nearly 30 different items that can cause taxpayers to fall into the AMT, a few are much more common than others. Here is a quick look at the “top ten” list of those that snare the most Alternative Minimum Taxpayers.

# 1 – Personal exemptions

For the Regular Tax, every taxpayer is entitled to a personal exemption deduction for himself, and his spouse and/or other dependents. Since the AMT denies any deduction for personal exemptions, this is the single item affecting almost every individual paying the Alternative Minimum Tax.

# 2 – State and local tax deduction

This item, which consists of property taxes, state and local income taxes, and sales taxes, is only slightly behind personal exemptions in terms of the number of AMT payers affected. The reasons for this are the relatively heavy burden of state and local taxes as well as the fact that the AMT disallows every dollar of this deduction.

# 3 -Capital gains

This is not specifically listed as an AMT item, but the impact of capital gains on an individual’s Alternative Minimum Tax can be significant. At levels of taxable income where most AMT payers find themselves, an additional $100 of capital gains could add up to $7 of AMT being paid on top of the $15 imposed by the Regular Tax capital gains bracket.

# 4 – Miscellaneous Itemized Deductions

A taxpayer’s employee business or investment-related expenses may be deductible under the Regular Tax, but they are not for the AMT. This affects nearly a third of all AMT payers.

# 5 – Depreciation

Business owners and investors with rental property are allowed depreciation deductions for the property used in these activities. The AMT disallows a portion of the depreciation deduction that otherwise may be taken.

# 6 – Passive activity losses

Many investment activities are considered “passive” for tax purposes. An example is a taxpayer who acquires an interest in an investment partnership. As such, losses from these investments are limited in how they may be deducted for purposes of the Regular Tax. The AMT imposes even further limitations on the use of these losses.

# 7 – Private activity bond interest

An individual investing in tax-exempt municipal bonds may receive an unpleasant surprise when he discovers that Alternative Minimum Tax has to be paid on the interest income from a certain type of municipal bond – the so-called private activity bond. While there may be an increase in before-tax yield from this type of bond, the after-AMT results can be very disappointing.

# 8 – Standard deduction

A taxpayer is allowed no standard deduction in computing the AMT. A valuable planning idea here could mean that an AMT taxpayer might be better off not claiming the standard deduction at all.

# 9 – Medical and dental expenses

For purposes of the Regular Tax, individuals are allowed a deduction for medical and dental expenses, to the extent these expenses exceed 7.5% of Adjusted Gross Income. The AMT limits this deduction even further by instead imposing an excess-of-10% requirement.

#10 – Limitations on investment losses

In addition to the limitation on the use of passive activity losses as discussed above, there are other investment activities, not falling under the passive rules, the losses from which still will be limited for purposes of the Regular Tax. Again, the AMT places even further limitations on the use of these losses.

Conclusion

In addition to this top ten list, there are nearly 20 other individual items waiting to trip up the AMT payer. The individual items that catch any particular taxpayer are shown on that individual’s Form 6251 that is attached to his tax return. It is important to note, however, that planning opportunities exist that can lessen the impact of each and every one of these. Check these out at AMTIndividual.com.

Posted in Capital gains & Dividends, Depreciation & Disposition of Property, K-1 / All other AMT Items, Medical And Dental, Misc Deductions 2-percent Floor, Personal Exemptions, Private Activity Bonds, Standard Deduction, State Income & Other Taxes | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 10

Tuesday, December 29th, 2009 | Print This Post | Email This Post

Year-End AMT Planning Wrap-Up – Part 2

The AMT items that were talked about in Part 1 of this wrap-up generally were the bigger ones that can, depending on a taxpayer’s situation, present immediate year-end Alternative Minimum Tax savings opportunities. But the other items that were discussed in this 10-week series also are important in making sure the least amount of AMT is paid. Here is a brief recap of these other items, with references to the amtblog.com articles in which each appeared.

Investments: Private Activity Bonds – an individual investing in tax-exempt municipal bonds can receive an unpleasant surprise when he discovers that AMT has to be paid on the interest income from a certain type of municipal bond. See the December 18th article posted on amtblog.com.

Miscellaneous Itemized Deductions – business or investment-related expenses may be deductible under the Regular Tax, but they are not for the AMT. Several planning ideas on how to minimize this impact are presented. See the November 14th article posted on amtblog.com.

Limitation on Itemized Deductions: AMT Adjustment – when a taxpayer is in the AMT, the limitations that apply to itemized deductions are calculated differently from the limitations that apply for the Regular Tax. See the November 25th article posted on amtblog.com.

State Income Tax Refunds: AMT Adjustment – because of the different AMT treatment of state and local tax deductions, any adjustment to these deductions – for example, a refund of overpaid state taxes which generally is treated as income when received – is itself then given different treatment for the AMT. See the November 29th article posted on amtblog.com.

Standard Deduction – a taxpayer is allowed no standard deduction in calculating the AMT. An interesting planning idea here could mean that an AMT taxpayer might be better off not claiming the standard deduction at all. For a discussion of this opportunity see the November 18th article posted on amtblog.com.

Personal Exemptions – similar to the standard deduction, a taxpayer is allowed no deduction for personal exemptions in calculating the AMT. Not a whole lot can be done here, but there always are at least a few planning ideas. See the November 22nd article posted on amtblog.com.

The AMT Exemption, also known as “the annual patch” – the AMT Exemption amount is set annually by Congress. This is a prescribed amount by which a taxpayer’s Alternative Minimum Taxable Income must exceed his Regular Tax taxable income before the AMT itself is triggered. If Congress were to fail to adjust this exemption amount, 24 million new taxpayers would be pulled into the AMT, in addition to the four-plus million already stuck there. See the December 21st article posted on amtblog.com. Also, pay careful attention to the news we will be seeing on this in the near future as we anxiously await Congress’ fix on this again for 2010.

Good luck with your AMT planning. Hopefully each of these articles provided a simplified explanation along with a few 2009 Alternative Minimum Tax savings ideas. Soon we’ll be working on 2010!

Posted in AMT Exemption, AMT Planning in General, Misc Deductions 2-percent Floor, Personal Exemptions, Private Activity Bonds, Standard Deduction | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 3

Saturday, November 14th, 2009 | Print This Post | Email This Post

“Miscellaneous” Itemized Deductions

It may seem odd that a category of expenses labeled “job expenses and certain miscellaneous deductions” could affect nearly a third of all taxpayers caught in the AMT, but that just happens to be the case. This category includes, in addition to job-related expenses that are not reimbursed by your employer, such other things as tax return preparation fees, investment-related expenses like fees paid to an investment advisor, trust fees, safe-deposit box fees, and any other expenses that are incurred in connection with earning the income that is shown on the tax return.

When calculating the Regular Tax, these types of expenses are deductible, but only if they exceed a certain percentage limitation. The limitation is 2 percent of the taxpayer’s Adjusted Gross Income, or “AGI.” For example, if AGI is $100,000, the taxpayer is allowed a deduction if the total of job-related and miscellaneous expenses exceeds $2,000 – but then only for the amount in excess of the $2,000.

For taxpayers stuck in the Alternative Minimum Tax, however, no deduction is allowed for miscellaneous itemized deductions. This difference between the Regular Tax and the AMT is reported on IRS Form 6251 as one of the numerous adjustments that must be made in calculating taxable income.

A couple of key planning tips here:

First, as with all itemized deductions, miscellaneous expenses are eligible to be deducted only in the year paid, whether by cash or by writing out and mailing, or actually delivering, a check. If a credit card is used, the date the charge is put on the card is the important date, even though the credit card bill is not paid until later when the bill comes in.

Second, as we’ve been preaching all along with other items such as state and local taxes, the key AMT planning step is determining whether the taxpayer has enough control over paying the expense so that he could choose to make it a deduction either in the current year or in the next year.

For example, if a taxpayer filed his 2008 return on the final extended due date of October 15, 2009, he probably wouldn’t be receiving the bill from his CPA until about now, in November. In this case, if the taxpayer is in the AMT in 2009 but will not be in the AMT in 2010, it makes more sense to pay the bill in January, 2010. So long as the 2 percent threshold is exceeded in 2010, there will be a Federal income tax benefit that otherwise would not be available if the bill were paid in 2009. Depending on the individual’s tax bracket, this savings could be up to 35 percent of the amount of this deductible expense.

There is nothing secret about this tax reduction opportunity – just the same basic and easily executed tax planning strategies as discussed in our earlier articles. Estimating your tax situation this year and next – to see if you are in or out of the AMT – and then just paying the bill in the more advantageous year is all there is to it.

Posted in Misc Deductions 2-percent Floor | 2 Comments »