AMT Items

I Own and Operate a Small Business – Does the AMT Apply to Me?

Sunday, January 30th, 2011 | Print This Post Print This Post | Email This Post Email This Post

First in a Series on Different Types of Taxpayers

Among the many paperwork burdens small business owners must endure is the filing and paying of income taxes for the business.  Even if no taxes currently are due because of losses, accurately computing and tracking of tax losses is a must.  And, as if the Regular Tax weren’t enough to contend with, the Alternative Minimum Tax also must be considered.  The purpose of this article is to discuss those specific aspects of the AMT that can apply to small business owners.

Who is responsible for the AMT – the small business itself or the individual owner?

The answer to this basic question depends on the legal structure of the business – i.e., how it is organized under state law.  Listed below are the common forms of doing business, with an explanation in each case of who is responsible for the AMT.

Sole proprietorship – if no separate legal entity is formed, the business and the individual owner are one and the same.  In this case, taxes are reported on a schedule attached to the individual’s personal tax return (Schedule C), and the individual is responsible for computing and paying the Alternative Minimum Tax.

Limited Liability Company (LLC) – this type of entity is formed under state law, but for income tax purposes it is treated as a “disregarded entity.”  If there is only one owner of the LLC, its tax reporting is the same as if it were a sole proprietorship.  If there are multiple owners, the entity is treated for tax purposes the same as a partnership (described below).

Partnership – a partnership is another form of entity created under state law.  For tax purposes, its income and losses – along with its AMT items – “pass through” directly to the partners.  The partnership files a tax return, but it as an entity does not pay any taxes because of this pass-through treatment.

Corporation – unless a corporation makes a “Subchapter S” election (see below) the corporate entity itself is the taxpayer.  These tax-paying corporations are referred to as “C corporations.”  This is the one type of business entity that pays its own Alternative Minimum Tax, separate and distinct from its owners.  This is done on Form 4626 – Alternative Minimum Tax—Corporations.

Subchapter S corporation – while formed as a corporation under state law just like a regular corporation, for income tax purposes if the shareholders make a “Sub S” election the entity is treated the same as a partnership for tax purposes.  As such, the AMT items pass through and are picked up by the individual shareholders.

What are the AMT items that apply to small business owners?

Set forth below are brief explanations of the more common AMT items affecting small businesses.  A detailed explanation of each of these can be found at www.amtindividual.com.

Depreciation – property used in a business can be depreciated for tax purposes, and there are choices to be made as to which depreciation method to use.  Some depreciation methods result in an AMT item while others do not, so this is an important consideration for the small business owner.

Gain or loss on sale of business property – when business property is sold or otherwise disposed of, at this point taxable gain or loss must be computed.  Depending on the depreciation method that was used (see above), gain or loss for purposes of the AMT may be different from what it is for the Regular Tax.

Net operating loss (NOL) – when a business has a tax loss, in certain cases that loss may be used to generate a refund of prior years’ taxes paid, and/or it may be carried forward to be used as a deduction against future years’ taxable income.  The AMT requires that the NOL be calculated differently than it is for the Regular Tax.

Qualified small business stock – a Regular Tax break applies to gain realized from the sale of stock of certain small businesses.  For the AMT, this break is less favorable than it is for the Regular Tax.

Special industries – businesses in certain industries are allowed favorable tax treatment under the Regular Tax, while the Alternative Minimum Tax denies some or all of these benefits.  Any of the following items in the businesses indicated can result in the AMT being paid:

Depletion allowances, mining costs, intangible drilling costs (oil and gas, mineral extraction)

Circulation costs (publishing)

Long-term contracts (construction)

Research & development/R&D (any business engaged in research)

Summary

In addition to the Alternative Minimum Tax rules that apply to everyone, small business owners have an extra set of concerns to deal with.  The key to effectively planning to minimize a business’ AMT burden is: 1) knowledge of the choices of tax treatment that are available, and; 2) access to computer software to model out the resulting AMT impact of each of the choices.  For an excellent source for both of these see http://www.amtindividual.com/alternative-minimum-tax-calculator-assistant101.html.

Posted in AMT Items, AMT Planning in General, Calculation of the AMT | 1 Comment »

Roth IRA Conversions and the Alternative Minimum Tax

Saturday, January 22nd, 2011 | Print This Post Print This Post | Email This Post Email This Post

Everyone with a traditional IRA should be looking into whether converting to a Roth IRA might make sense for them, because the ability to shelter future earnings from taxation is a very attractive feature of the Roth.  The difficult part in doing a conversion analysis, however, is in forecasting the tax bracket that will apply when the IRA monies are distributed in the future.  For alternative minimum tax payers, the Roth analysis can be especially difficult.

Roth IRA vs. traditional IRA

Contributions to a traditional IRA are tax-deductible when made, subject to income restrictions and other limitations.  In return, distributions taken from the IRA, typically in retirement, are taxable, along with the earnings on the IRA while it was invested.  For a Roth IRA, on the other hand, there is no tax deduction when the contributions are made, and in return there is no taxable income at the time of taking distributions.  The feature particularly attractive to a Roth is that the earnings also are not taxable.

Roth conversions

Prior to 2010 there were income limits on who was allowed to convert a traditional IRA to a Roth IRA.  These income limits prevented most folks who had the wherewithal to make such a conversion from being able to do so.  The removal of these income limits has resulted in a lot of articles being written on this issue, and many investment advisers continue to meet with their clients to try to figure out whether or not a conversion sense for them.

The basics of a Roth conversion are simple.  In exchange for paying taxes now, an individual will pay no taxes when the monies are withdrawn from the IRA.  Sounds simple, yes, but the analysis actually is pretty difficult because of the variables involved, particularly the individual’s tax rates, both now and in the future.

Example

Assume an individual has a traditional IRA with a balance of $100,000, and has been able to deduct all of the contributions that have been made to it.  If that individual is in the 35 percent tax bracket, electing to convert it to a Roth today will mean tax due of $35,000.  The remaining balance of $65,000 will continue to be invested, and at retirement there will be no taxes due on the $65,000 or on any of the investment earnings.  If one assumes investment growth of 50 percent between now and retirement, the individual will end up with a tax-free distribution of $97,500.

Compare this to leaving the IRA alone and not making the conversion.  Fifty percent growth will mean the IRA will be worth $150,000 at retirement, before tax.  If the individual is still in the 35 percent bracket, the tax will be $52,500, leaving a net amount for the individual of $97,500.  How interesting, one notes – the result is exactly the same!

Tax planning for a Roth conversion

So now you know the “secret” behind the Roth conversion analysis – investment yield is irrelevant.  The entire analysis is in the tax rates – what tax bracket you are in today vs. what tax bracket you expect to be in at retirement.  With Republicans fighting Democrats over who is and who is not “rich,” and continuous last-minute temporary “extenders” of our individual income tax rates it is, in fact, almost impossible to do with any degree of accuracy.  But that doesn’t mean the analysis shouldn’t be done.  Set forth below is all the information you need.

What tax bracket are you in in 2011?

Using the married-filing-jointly status as an example, here are the 2011 tax tables, if you are paying the Regular Tax:

Up to $17,000                         10%

Excess up to $69,000              15%

Excess up to $139,350            25%

Excess up to $212,300            28%

Excess up to $379,150            33%

Over $379,150                                    35%

Here are the tax tables, if you are stuck in the Alternative Minimum Tax:

Up to $175,000                       26%

Over $175,000                                    28%

What tax bracket will you be in after you retire, at the time of taking the IRA distributions?

This, of course, is the really hard part, especially in view of the ongoing push from some of our leaders in Washington (i.e., the Democrats) to raise our tax rates.  There are three choices in how to approach this:

One is to assume you will be in the Regular Tax, and that the Republicans will somehow keep our tax brackets the same as they are today.  In this case, use the Regular Tax table shown above.

Another is to assume you will still be stuck in the AMT, and that those brackets will remain what they are today.  Here one would use the AMT tax table above.

The third is to forecast what the tax brackets will be if the Democrats succeed in raising our taxes.  While it is of course impossible to predict what might ultimately come out of Washington, as a starter here are projected brackets prepared by the Tax Foundation, a Washington-based tax “think tank,” under what it calls a “full expiration” scenario:

Up to $57,650                         15%

Excess up to $139,350            28%

Excess up to $212,300            31%

Excess up to $379,150            36%

Over $379,150                                    39.6%

For reference, other scenarios also are presented on the Tax Foundation’s web site.

State income taxes

In addition to the core tax bracket analysis using Federal tax rates, consideration also must be given to state income taxes.  A state income tax rate of 6 percent would mean another $6,000 in taxes in the above example.  The two things to consider here are: 1) the effect of state income taxes on one’s Alternative Minimum Tax (high state taxes are the most common problem for AMT payers), and; 2) the possibility that retirement could involve relocating to a state with no income tax (Florida, for example).  Either or both of these would have a significant impact on a conversion analysis.

Summary

Roth conversions can make sense in situations where the taxes paid today are less than what they otherwise would be at retirement.  As with all tax planning, no generalizations can be made.  Everyone’s situation is different, so one has to take a big gulp and make a best guess on the future tax bracket that will apply.  Also, an online calculator is a must, especially when doing AMT planning.  For an excellent one that is not only easy to use but also free see http://www.amtindividual.com/alternative-minimum-tax-calculator-assistant101.html.

Posted in AMT Planning in General, Calculation of the AMT, Legislation/tax law changes, State Income & Other Taxes | 1 Comment »

Last-Minute AMT Calculations and Planning

Thursday, December 30th, 2010 | Print This Post Print This Post | Email This Post Email This Post

The last-minute tax relief bill signed just a few weeks ago may have saved many from being pulled into the Alternative Minimum Tax for the first time, but what about the four million individual taxpayers already stuck there?  Not even a “thank-you” from Congress or the President for the billions of dollars paid each year in AMT by these folks, much less any relief being planned – our country’s spending habits are just too great.  But, while there is no way to make it just go away, there certainly is something these individuals can do about the AMT.  With the help of a computerized AMT calculator, the amount of AMT paid can be reduced.

Let’s look at some facts.  Last week the IRS released its Statistics of Income Report for tax returns filed in 2009, with some staggering information on the AMT.  Here is what it shows:

-          The average amount of AMT paid was $6,500.

-        For the sixth straight year, the total amount of AMT paid showed a substantial increase – more than six percent higher than the prior year.

-          There are taxpayers at every income level – from $0 of income to over $10 million – paying the AMT.

-          Once income reaches $100,000, the chances of being pulled into the AMT become much greater.

-        The income range of $200,000 to $500,000 is the unfortunate AMT “sweet spot,” with an amazing 70% of all taxpayers in this group paying the AMT.

So what can you do about your $6,500?  Particularly for those in the “sweet spot” income range, chances are most of your AMT is being triggered by the one single item found on nearly 95% of all AMT payers’ tax returns – state and local taxes.  The biggest culprits in this area are state taxes on income and property taxes on one’s home, with city and other municipal taxes, if those apply, compounding the problem.  The AMT rule that comes into play here is the one that allows a full deduction for these taxes when computing the Regular Tax liability, yet denies any deduction for these when computing the AMT.

For example, suppose a family of four has taxable income for the Regular Tax – the starting point in all AMT computations – of $200,000.  State income taxes and real estate taxes easily could amount to $20,000 worth of itemized deductions.  What this means is that taxable income for this family for the Alternative Minimum Tax would be $234,600 – nearly 20% higher.  This is because personal exemptions, worth $14,600 to this family in 2010, also are denied as a deduction for the AMT.  Note that this simple example doesn’t even consider the 20-plus other AMT items that could affect this taxpayer (see IRS Form 6251).  With this big a difference in taxable income, one can almost guarantee that this taxpayer will be stuck in the AMT.

So, again, what can be done?  With an AMT calculator, it’s actually pretty easy.  Suppose a property tax bill could be paid this year or in January of next year.  If you move a $5,000 AMT item from one year to the next, it could mean lowering your AMT by nearly $1,500.  If you could move $5,000 of state income taxes from one year to the next, now you have potentially $3,000 of AMT savings.  It’s that easy!

But to do these calculations by hand is way too cumbersome, and of course prone to mistakes.  That’s where a computerized calculator, like the one available – for free – at http://www.amtindividual.com/alternative-minimum-tax-calculator-assistant101.html, is essential.  This web site also will hand-walk you through all of the AMT items, allowing you to make the most accurate calculations possible.

Give it a try.  Wouldn’t you rather put an easy $1,000 or more in your pocket rather than simply continuing to just turn it over to the Government?

Posted in AMT Items, AMT Planning in General, Calculation of the AMT, Legislation/tax law changes, State Income & Other Taxes | No Comments »

Fall AMT Planning Series – Miscellaneous Itemized Deductions

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

Real Estate and the AMT: Property Used in the Taxpayer’s Trade or Business

Sunday, October 10th, 2010 | Print This Post Print This Post | Email This Post Email This Post

The Alternative Minimum Tax is a very important consideration when real estate is involved because just about every tax rule applying to real estate is different for the AMT than it is for the Regular Tax.  This last part of our four-part series will talk about real estate used in a taxpayer’s trade or business.  This is a big investment for most small businesses, and the differences in tax treatment between the Regular Tax and the AMT can be significant.

For this article we are talking about businesses held in the form of a sole proprietorship, an S corporation, an LLC or a partnership.  All of the Regular Tax and AMT issues discussed here show up on the individual owner(s) Form 1040 because every one of these types of businesses is treated as a “pass-through” entity for tax purposes.

Following the order of the issues described in the earlier parts of this series, here is a look at them as they apply to trade or business property.

Interest expense

Interest paid on a mortgage taken out to acquire business property is fully deductible, both for the Regular Tax and the Alternative Minimum Tax.  Similar to the last article on rental/investment property, the limitations discussed in the first article on home mortgage interest simply not apply.

If the equity in the business property is used as security for an additional loan – a second mortgage, for example – then the taxpayer must look to the use of the proceeds of that loan.  If the proceeds are used for a car loan or to finance a child’s education or for any other purpose, then the interest is nondeductible personal interest.  So long as the proceeds are used in the business, the interest is fully deductible.

Property taxes

Property taxes paid on trade or business property are allowed in full both for Regular Tax purposes as well as for the Alternative Minimum Tax.

Depreciation

Depreciation is allowed for property used in a trade or business.  The portion of the cost allocable to land is not depreciable, but for the building itself and the furniture & equipment a depreciation deduction may be taken.

Real property (the legal definition of the building) used in a trade or business may only be depreciated for Regular Tax purposes under the “straight line” method over a useful life of 39 years.  Thus, a property with $390,000 allocated to the building would be depreciated at the rate of $10,000 per year.

Personal property (this is the legal definition of things such as machinery and equipment, furniture and fixtures, and computer equipment) may be depreciated for Regular Tax purposes under an “accelerated” method over a useful life of five or seven years.  An accelerated method allows a larger depreciation deduction in the early years, in recognition of the obsolescence factor in new property (computers are a good example).

For purposes of the AMT, however, personal property may only be depreciated by using a straight-line method.  Thus, an AMT item will be generated in the early years if the accelerated method is used.

Planning idea – consider electing to use the straight-line method of depreciation for Regular Tax purposes.  While giving up a little tax benefit from the greater depreciation in the early years, it could mean avoiding paying the AMT.

Active/passive investment rules and the “at-risk” rules

The active/passive investment rules generally do not apply to a small business, because the business owner almost always is heavily involved in the day-to-day operations of the enterprise, and, thus, by definition is active.  These rules would apply, however, to a financing partner or a silent partner who is not so involved.  As a reminder, these rules as well as the at-risk rules would apply only in the years the business had losses.

Sale of the property

Several different AMT issues can arise on the sale of business property.  These are essentially the same issues as those discussed in the last article, on Rental/Investment Property, with perhaps a few minor differences.

One AMT issue is that the taxpayer’s gain or loss will be different for the AMT than it is for Regular Tax purposes if the business personal property was depreciated using an accelerated method for Regular Tax purposes.  Because the straight-line method had to be used for Alternative Minimum Tax purposes, the gain or loss will be different and the taxpayer will have an AMT item to report on the Form 6251.

Gains on the sale of business property generally are capital gains, although a portion will be treated as ordinary income if the accelerated depreciation method was used.  Capital gains in and of themselves are not an AMT item, but they definitely can result in AMT being paid.  This is because the AMT exemption – that keeps many taxpayers out of the Alternative Minimum Tax – is phased out for taxpayers above certain income levels.  Additional income, even capital gains, can have the result of reducing the exemption which in turn increases taxable income for AMT purposes.

This issue is discussed in an article posted on amtblog.com on December 13, 2009.  This article also can be found by searching for “alternative minimum tax planning – investments – capital gains.”

This is the final of four articles on Real Estate and the AMT.  A new series of articles will begin soon, focusing on different types of taxpayers and the things to watch out for, along with associated planning opportunities, for each of these types.  Stay tuned!

Posted in AMT Planning in General, Capital gains & Dividends, Depreciation & Disposition of Property, Investment Interest Expense, State Income & Other Taxes | No Comments »

Fall AMT Planning Series – Property Taxes

Saturday, October 9th, 2010 | Print This Post Print This Post | Email This Post Email This Post

Similar to state income taxes, for Regular Tax purposes a taxpayer is allowed a deduction for all property taxes that are paid.  Under the AMT, however, the taxpayer is allowed no deduction for property taxes.  This problem affects almost 100 percent of all individuals paying the Alternative Minimum Tax, so it is something that one definitely needs to look into.  This also represents one of the easiest AMT planning opportunities that an individual taxpayer can do something about.

Real estate taxes

Property tax assessment and billing cycles vary among the states, but the basic concept to consider is the control a taxpayer may have over paying a tax bill in December or in January.  As was previously discussed in the article on state income taxes, this same concept also applies to property taxes.

Shown below is an example of an actual property tax bill a homeowner would have received on a $500,000 residence in a state that assesses the tax in the fall, and then gives the taxpayer a choice of payment dates in accordance with a set schedule over a period of several months.  With this example it is easy to see the direct impact on the AMT a taxpayer can have.

Example:

Assessed property value $500,000
Property tax rate 1.0724%
Property tax due $5,362
Due date 12/31/10
The payment schedule as shown on the actual bill:
If paid by 10/31/10 the amount due is $5,255 (2% discount)
“ 12/31/10 “ 5,362 (full amount)
“ 1/31/11 “ 5,630 (5% penalty)
“ after 1/31/11 “ 6,488 (21% penalty)

The AMT-saving strategy for property taxes is extremely simple in this example, since the taxpayer has a choice of paying the property taxes in 2010 or in January, 2011.  The simple act of when the check is written out will have a direct impact on the amount of AMT paid.  As mentioned above, a taxpayer would get no benefit from a property tax deduction in a year he is in the AMT.  By paying the property taxes in a year the individual is not in the AMT, however, real tax savings will be achieved.

In this example, if the taxpayer is in the AMT this year but does not expect to be in the AMT in 2011, by waiting until January to pay this bill up to 35% in Federal income taxes (39.6% is tax rates are allowed to increase) could be saved.  This obviously is much greater than the 2% discount that would be foregone, as well as the 5% penalty that would be incurred.

A particular state’s property tax assessment and billing cycle likely will vary from this example, but the concept applies to all taxpayers – to the extent an individual can, without incurring penalties with which he would not be comfortable, control even a portion of the timing of payment of property taxes, savings will be realized on his AMT bill.

Personal property taxes

Many states impose taxes on the value of personal property.  Common examples are automobiles, boats, RVs and the like.  Similar to real estate taxes, personal property taxes are deductible for the Regular Tax but not for the Alternative Minimum Tax, so here is one more planning opportunity.  The dollars may be smaller, but if it is easy to do, why not?

Assume a state’s personal property tax rate is 1.5%, for example, and the taxpayer owns a $40,000 car.  The property tax on this automobile will be $600.  If there is an opportunity to pay this tax in one year versus another (see the December – January example above), this could be an easy way to shave a few hundred dollars off an individual’s AMT bill.

The higher a state’s property taxes are, the more important it is that Alternative Minimum Tax payers give this item some personal attention.

Posted in AMT Planning in General, State Income & Other Taxes | No Comments »

Real Estate and the AMT: Rental or Investment Property

Wednesday, October 6th, 2010 | Print This Post Print This Post | Email This Post Email This Post

The Alternative Minimum Tax is a very important consideration for taxpayers who own real estate because just about every tax rule applying to real estate is different for the AMT than it is for the Regular Tax.  This third part of our four-part series on Real Estate and the AMT will address those situations where the individual holds the real estate as an investment, typically as rental property.  The differences in tax treatment between the Regular Tax and the AMT can be significant.

Following the order of the issues described in the earlier articles in this series, here is a look at them as they apply to rental/investment property.

Interest expense

Interest paid on the mortgage taken out to acquire the property is fully deductible, both for the Regular Tax and the Alternative Minimum Tax.  Unlike itemized deductions that allow a tax benefit for what amounts to personal expenses, the tax law generally allows all deductions a taxpayer has to make in the pursuit of business income. Thus, the limitations discussed in the previous article on home mortgage interest do not apply.

If, however, the equity in the rental property is used as security for an additional loan – a second mortgage, for example – then the taxpayer must look to how the proceeds of that loan are used to determine interest deductibility.  If the proceeds are used for a car loan or to finance a child’s education, for example. then the interest is nondeductible personal interest.  If the proceeds are used to improve the rental property, the interest is deductible.

Suggestion – it is best that taxpayers keep personal borrowings separate from business borrowings.  Mixing the two creates recordkeeping challenges and can result in disputes with the IRS.

Property taxes

Property taxes paid on rental or investment property are allowed in full both for Regular Tax purposes as well as for the Alternative Minimum Tax.

Planning idea – if you have an opportunity to pay your property tax bill either this year or next, pay it in a year when you have enough income from the property so as not to generate a rental loss.  This strategy can help avoid triggering the passive activity loss limitations described below.

Example – in Florida property tax bills are mailed in October, and are payable under the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%.  If you have a loss from the property in 2010 but expect to generate income in 2011, do not pay your bill in November or December – forgoing that small discount could help you avoid the loss-limitation rules.

Depreciation

Depreciation is allowed for property held for investment.  The portion of the cost allocable to land is not depreciable, but for the building itself and the furniture, appliances, carpeting, etc. a depreciation deduction may be taken.

Real property (this is the legal definition of the house or other building) held for rental/investment may only be depreciated for Regular Tax purposes under the “straight-line” method, over a useful life of 27.5 years.  Thus, a property with $275,000 allocated to the building would be depreciated at the rate of $10,000 per year.

Personal property (this is the legal definition of things such as furniture, appliances, carpeting and the like) may be depreciated for Regular Tax purposes under an “accelerated” method over a useful life of five years.  An accelerated method allows a larger depreciation deduction in the early years, in recognition of an obsolescence or decline-in-value factor that you see in new property (cars are a good example).

For purposes of the AMT, however, personal property may be depreciated only by using a straight-line method.  Thus, an AMT item will be generated in the early years if the accelerated method is used.

Planning idea – for personal property consider electing the straight-line method for Regular Tax purposes.  While giving up a little tax benefit from the greater depreciation in the early years, it could mean avoiding paying the AMT.

Active/passive investment rules and the “at-risk” rules

A taxpayer who is not “active” in managing investment property may not use losses from rental property to offset other income such as salaries and wages, dividends, interest, capital gains, etc.  Instead, these losses are deferred until the taxpayer either sells the property or generates passive income from this or other passive investment sources.

The at-risk rules similarly deny using these types of losses to the extent the taxpayer has acquired the investment with borrowed money and does not have personal liability on the debt.

Planning idea

If these loss limitations apply, consider the planning ideas mentioned above to minimize the losses being generated each year.  They are not doing you any good anyway.

Sale of the property

Several different AMT issues can arise on the sale of rental/investment property.  One is that your gain or loss may be different for the AMT than it is for Regular Tax purposes.  This would be caused if different depreciation methods were used.  For example, if the personal property was depreciated using an accelerated method for Regular Tax purposes, then the basis in that property when calculating gain or loss on sale would be different because the straight-line method had to be used for Alternative Minimum Tax purposes.

Gain on the sale of investment property generally is capital gain, although a portion may be treated as ordinary income depending on the accelerated depreciation method was used.  Capital gains in and of themselves are not an AMT item, but nonetheless they can result in AMT being paid.  This is because the AMT exemption amount is phased out for taxpayers at certain income levels, so this additional income can have the result of reducing the exemption which in turn increases taxable income for purposes of the Alternative Minimum Tax.

This issue is discussed in some detail in an article posted on amtblog.com on December 13, 2009.  This article also can be found by doing an internet search for “alternative minimum tax planning – investments – capital gains.”

Next in this series on Real Estate and the AMT – property used in a taxpayer’s trade or business.

Posted in AMT Planning in General, Capital gains & Dividends, Depreciation & Disposition of Property, Investment Interest Expense, State Income & Other Taxes | No Comments »

Fall AMT Planning Series – State Income Taxes

Sunday, October 3rd, 2010 | Print This Post Print This Post | Email This Post Email This Post

For Regular Tax purposes you are allowed a deduction for all state income taxes that you pay.  If you are stuck in the Alternative Minimum Tax, however, you are allowed no deduction for state income taxes.  This problem affects almost 100 percent of all individuals paying the Alternative Minimum Tax, so it is something that you definitely need to look into.  This also represents one of the easiest AMT planning opportunities that you can do something about.

Overview

Every state that has an income tax requires that you pay your tax throughout the year.  This can be done either through withholding from your paycheck if you are an employee, or through quarterly estimated payments if you are self-employed, retired, or have not adjusted your withholding to cover the additional taxes you will owe on your investment income.

Two key rules that apply to all states

1 – No state requires you to pay in 100% of your state tax liability – the required percentage generally is 80% or 90%.  If you don’t pay in this required amount you may be subject to an underpayment penalty, which usually is calculated in a manner similar to interest.

2 – If you make quarterly estimated tax payments, the fourth quarter payment is generally due on January 15 – for example, January 15, 2011 for the fourth quarter installment of your 2010 taxes.  This is the way the IRS works, and most states follow this pattern.

How to do this simple tax planning

The AMT-saving strategy here is to focus on the control you have over the payment of this last 10 or 20 percent you will owe, or, if applicable, your fourth quarter installment.  Since you have the choice of paying this portion of your state income taxes in December or in January, the simple act of when you write out the check will have a direct impact on the AMT you will pay.  As mentioned above, you get no benefit from a state income tax deduction in a year you are in the AMT.  By putting more of your state income taxes paid in a year you are not in the Alternative Minimum Tax, you will achieve real tax savings.

Example

Assume that you are in the AMT in 2010, your total 2010 state taxes are $15,000, you will not be in the AMT in 2011, and your Regular Tax bracket is 35%. If you could defer paying $1,500 of your 2010 state income tax until January, this would save you over $500. If you could defer $3,000, your savings would be over $1,000.  Note that even if you end in the AMT again next year, continuing to execute this strategy will mean that you will achieve this Regular Tax benefit in the first year that you are not in the AMT.

If you are certain that you will not be in the AMT next year, consideration might be given to delaying payment of more than the allowable percentage, even if it means incurring an underpayment penalty. The underpayment penalty for many states is at an interest rate of around 6% – incurring this small penalty obviously still will result in a lot more tax-savings cash in your pocket when you think about the Federal tax savings of up to 35%.

What you’ll need

If you do decide to pursue a state income tax strategy, first you will need to check the rules for making estimated payments for the state in which you live.  All states have the necessary forms and related instructions that you will need available on their web sites.

The three key forms are each state’s equivalent of the following IRS forms:

  • Form W-4, Employee’s Withholding Allowance Certificate – This can be filed at any time with your employer to adjust your withholding up or down.
  • Form 1040-ES, Estimated Tax for Individuals – This is used to make quarterly estimated tax payments if you are self-employed or retired, or if you have not adjusted your withholding for the additional taxes due on your investment income.
  • Form 2210, Underpayment of Estimated Tax by Individuals – This is used to determine whether you have paid in the required percentage.  By reading the instructions you will see what your state’s required minimum pay-in percentage is.

Conclusion

Look at the potential cash benefit to you, as seen in the example above, from making this small investment of your time.  You the individual taxpayer can do this without the need to spend money on expensive professional advisers.  One very easy way to tackle this is to log on to AMTIndividual.com, where all of the explanations, links to the forms for your own state, and an easy-to-use online dual tax calculator/planner are available to help you make a significant reduction in your Alternative Minimum Tax!

Posted in State Income & Other Taxes | No Comments »

Real Estate and the AMT: Home Ownership

Tuesday, September 21st, 2010 | Print This Post Print This Post | Email This Post Email This Post

The Alternative Minimum Tax is a very important consideration for taxpayers who own real estate because just about every tax rule applying to real estate is different for the AMT than it is for the Regular Tax.  This second part of our four-part series on Real Estate and the AMT will address the most common form of real estate ownership – the taxpayer’s personal residence.  Typically this is a taxpayer’s largest purchase, and the differences in tax treatment between the Regular Tax and the AMT can be significant.

Following the order of the issues described in our previous overview article, here is a look at how they apply to a personal residence:

Interest expense

Interest paid on a loan secured by a taxpayer’s home, referred to in the tax law as “qualified residence interest,” is deductible for purposes of the Regular Tax, subject to a few limitations.  Interest on home acquisition debt is deductible in full to the extent the mortgage does not exceed $1 million, as is interest on home equity debt to the extent the debt does not exceed $100,000.  Home equity debt, typically a second mortgage or a home equity line of credit, can be used for any purpose – a car loan or a child’s education are examples.

Under the AMT, a taxpayer is allow a full deduction for home acquisition debt.  For home equity debt, however, it is AMT-deductible only if it is used to improve the residence, i.e., if it used for other purposes, such as the car loan or student loan mentioned above, it is not deductible for the AMT.

Planning idea – look to alternative means of financing instead of home equity debt when financing automobile purchases, college tuition, or other personal purposes.  A special-offer automobile loan at 1.9%, for example, certainly would be less expensive financing than a home equity loan for an AMT payer.

Property taxes

Property taxes are allowed in full for Regular Tax purposes, but, along with all other state and local taxes, are not allowed at all as a deduction for the Alternative Minimum Tax.

Planning idea – if you have an opportunity to pay your property tax bill either this year or next, pay it in a year that you are not in the AMT.  Depending on levels of income, itemized deductions and other factors, taxpayers may find themselves in the AMT one year but not the next.

Example – in Florida, property tax bills are mailed in October, and are payable under the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%.  If you are in the AMT in 2010 but expect not to be in the AMT again in 2011, do not pay your bill in November or December  - forgoing that small discount could save a taxpayer up to 39.6% of the amount of the property taxes on his Federal income tax bill next year.

Depreciation

Depreciation does not apply to a personal residence, except perhaps for a taxpayer claiming a portion of his residence as a “home office” or other business use.  This topic will be discussed in some detail under the topics of rental/investment property and business property in the next two articles in this series.

Active/passive investment rules and the “at-risk” rules

Similar to Depreciation, these rules will be discussed in the next articles in this series; they do not apply to property held as a personal residence.

Sale of the property

A sale of a personal residence is not taxable to the extent the gain does not exceed $500,000, for a married couple filing jointly, or $250,000 for a single taxpayer.  Any gains over these amounts are taxable, as long-term capital gains.  Capital gains in and of themselves are not an AMT item, but they nonetheless can result in AMT being paid.  This is because the AMT exemption amount is phased out for taxpayers at certain income levels, so this additional income can have the result of reducing the exemption which, in turn, increases taxable income for purposes of the Alternative Minimum Tax.

This issue is discussed in some detail in an article posted on amtblog.com on December 13, 2009.  This article also can be found by doing an internet search for “alternative minimum tax planning – investments – capital gains.”

Next in this series on Real Estate and the AMT – property owned as rental/investment property.

Posted in AMT Planning in General, Capital gains & Dividends, Depreciation & Disposition of Property, Home Mortgage Interest, State Income & Other Taxes | No Comments »

It’s September: Time to Start our Fall AMT Planning Series

Saturday, September 18th, 2010 | Print This Post Print This Post | Email This Post Email This Post

“It’s the time of the season” was the way we introduced this Fall planning series a year ago.  Swimming pools are closed, the kids are back in school, and the foliage may be starting to turn.  Only a few of you stragglers are on final extension to October 15 for your 2009 returns.  It’s time to start thinking about 2010!

Do you have an idea yet whether you’ll owe more taxes in April or be getting a refund?  Do you remember that you do have the opportunity – now – to make your April refund bigger or the check you write the IRS smaller?  All it takes is a brief look at your tax situation today, and knowing a little about what you can do between now and year-end.  If you wait until January it’s too late to do much about lowering your 2010 taxes.

This is especially true for those of you who are stuck in the Alternative Minimum Tax, and once again will be filling out the Form 6251.  For AMT payers, there is a long list of ways  to reduce your AMT bill, and all of them are simple and easy to do.

Over the next several months we’ll be doing a series of articles on what these planning ideas are, and we’ll drill down in some detail so you can understand the AMT issue itself and the resulting planning opportunities.

Here is a sample of what we’ll be talking about:

Property taxes – many of you already have received your property tax bill.  Assuming you have a choice of paying it in December or in January, the simple act of when you write out the check can have a direct impact on the AMT you’ll pay.

State income taxes – similar to property taxes, your state income taxes have an impact on your AMT.  The more state taxes you pay this year the higher your AMT bill will be – another opportunity to have an immediate impact on the tax you’ll pay.

Example – assume you owe $5,000, either in property taxes or in additional 2010 state income taxes.  If you are in the AMT this year and pay these taxes in 2010, you will get zero tax benefit.  If you wait until January to pay the $5,000, and then if you are not in the AMT in 2011, you will achieve a tax savings from the IRS of up to nearly $2,000.

There are many other ideas – simple ones like this – that we’ll be writing about between now and year-end, and we’ll be explaining each one in plain English so you can understand them and act on them.  Don’t wait any longer – “it’s the time of the season.”

Posted in AMT Planning in General, State Income & Other Taxes | No Comments »

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