Personal Exemptions

National Taxpayer Advocate Rips the AMT and Calls for its Repeal

Sunday, February 3rd, 2013 | Print This Post | Email This Post

As she has each year for the past decade, IRS National Taxpayer Advocate Nina Olson calls once again in her annual report to Congress for repeal of the Alternative Minimum Tax. Using labels such as “difficult,” “complicated,” “burdensome,” and a “penalty” to describe the AMT, she also notes that it hits particularly hard those “taxpayers who have not done any tax planning.” Realistically, Congress is not about to repeal this money-making machine, so the only solution is for individuals to undertake some basic tax planning to minimize the effect of this tax. Some important criticisms of the AMT that are made by Ms. Olson in her report are set forth below.

The Alternative Minimum Tax has failed to achieve its original goal

The report cites statistics showing that more than 35,000 taxpayers with incomes above $200,000 pay no income tax at all – neither the Regular Tax nor the AMT. How can this be? The primary reason is that tax exempt municipal bonds, with the exception of so-called “private activity bonds,” are totally exempt from taxation, both for the AMT as well as the Regular tax. This is one of the “loopholes” that Congress has not closed.

The AMT hits middle-income families who live in high-tax states particularly hard

The tax law allows a deduction for personal exemptions in computing the Regular Tax, generally recognizing the fact that the larger a family is the more income it needs to spend on meeting basic needs. For 2013 this exemption is $3,900 per individual, so a family of four will not have to pay tax on the first $15,600 of income. Unfortunately, personal exemptions are disallowed in computing the Alternative Minimum Tax, which means that the larger the family the more likely the taxpayer will be stuck paying the AMT.

Also, the Regular Tax deduction for state and local taxes is not allowed for purposes of the Alternative Minimum Tax. Unfortunately, states with the highest state and local tax burden, and, thus, the highest AMT risk, are the most populous states – California and the New England states, including New York and New Jersey for example. Too many families are getting stuck with the AMT just because they have children and happen to live in a high tax state.

The AMT is complicated and burdensome

Compliance costs for dealing with the Alternative Minimum Tax are almost unbelievable. In a recent study the IRS estimated that taxpayers in the aggregate spent over 18 million hours completing and filing the AMT form, whether they needed to or not. This amounts to over 12 hours for each person who actually paid the tax. By comparison, the IRS estimates that it takes 22 hours to fill out the entire Form 1040. Way too much time is being spent on the AMT, much of it unnecessary.

Other calls for repeal

The Taxpayer Advocate isn’t the only one calling for repeal of the AMT. As noted in her report, in 1999 Congress voted to repeal the AMT but the legislation was vetoed by the President. Both the 2005 Tax Reform Panel and the 2010 National Commission on Fiscal Responsibility and Reform recommended repealing the AMT. Over the years both Democratic and Republican leaders in the House and the Senate have also proposed repealing it, but none of this ends up going anywhere.

Conclusion

The AMT is difficult to repeal, and most likely never will be repealed, because of the significant amount of revenue that it raises. Accepting this fact, the only thing individual taxpayers can do is to look out for themselves, and, as suggested by Ms. Olson, get involved in doing some basic tax planning.

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

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

Sunday, May 15th, 2011 | Print 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 »

Joint Committee on Taxation – Tax Expenditures and the Alternative Minimum Tax

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

The Joint Committee on Taxation recently issued a report on tax expenditures. “Tax expenditures” are government spending that is accomplished through the Internal Revenue Code – in effect a negative tax. The tax expenditure term was created over 40 years ago by Stanley Surrey, then Assistant Secretary of the Treasury, as a way to describe the political use of tax breaks for means that were more typically accomplished through direct government spending.

Set forth below is an excerpt from this recent report – the part addressing the Alternative Minimum Tax. It makes for interesting reading, especially when one finds such comments as “the AMT is not viewed as part of normal income tax law.”

The report:

Under the Joint Committee staff view of normal tax law, compensatory stock options would be subject to regular income tax at the time the options are exercised and employers would receive a corresponding tax deduction. If the option has a readily ascertainable fair market value, normal law would tax the option at the time it is granted and the employer would be entitled to a deduction at that time. The employee’s income would be equal to the difference between the purchase price of the stock and the market price on the day the option is exercised.

Present law provides for special tax treatment for incentive stock options and options acquired under employee stock purchase plans. When certain requirements are satisfied, then: (1) the income that is received at the time the option is exercised is excluded for purposes of the regular income tax but, in the case of an incentive stock option, included for purposes of the alternative minimum tax (“AMT”); (2) the gain from any subsequent sale of the stock is taxed as a capital gain; and (3) the employer does not receive a tax deduction with respect to the option. The special tax treatment provided to the employee is viewed as a tax expenditure by the Joint Committee staff. However, it should be noted that the revenue loss from the special tax treatment provided to the employee is accompanied by a significant revenue gain from the denial of the deduction to the employer. The negative tax expenditure created by the denial of the deduction for employers is incorporated in the calculation of the tax expenditure.

The individual AMT and the passive activity loss rules are not viewed by the Joint Committee staff as a part of normal income tax law. Instead, they are viewed as provisions that reduce the magnitude of the tax expenditures to which they apply. For example, the AMT reduces the value of the deduction for State and local income taxes (for those taxpayers subject to the AMT) by not allowing the deductions to be claimed in the calculation of AMT liability. Similarly, the passive loss rules defer otherwise allowable deductions and credits from passive activities until a time when the taxpayer has passive income or disposes of the assets associated with the passive activity. Exceptions to the individual AMT and the passive loss rules are not classified as tax expenditures by the Joint Committee staff because the effects of the exceptions already are incorporated in the estimates of related tax expenditures. In one case the restrictive effects of the AMT are presented separately because there are no underlying positive taxexpenditures reflecting these effects: the negative tax expenditures for the AMT’s disallowance of personal exemptions and the standard deduction.

Posted in Incentive Stock Options Exercised, Legislation/tax law changes, Personal Exemptions, Standard Deduction, State Income & Other Taxes | 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 4

Sunday, November 22nd, 2009 | Print This Post | Email This Post

Personal Exemptions

A personal exemption deduction is allowed for a taxpayer, a spouse and any dependents such as children and other relatives. The amount for 2009 is $3,650 for each exemption, but this amount is reduced if the taxpayer’s Adjusted Gross Income (AGI) exceeds a certain amount.

In calculating the Alternative Minimum Tax, however, no deduction is allowed for personal exemptions. Thus, AMT taxable income will be higher than Regular Tax taxable income by the amount of exemptions claimed. For example, a married taxpayer with two children would be entitled to a Regular Tax deduction of $14,600 for these exemptions. If Regular Tax income for this family were $100,000, then AMT income would be $114,600.

There really isn’t anything that can be done to change the AMT effect of personal exemptions for the taxpayer and spouse – the tax law simply takes them away for purposes of the AMT. However, if there are dependents, a few situations exist where there may be planning opportunities to save taxes within the family unit.

One example is if the dependent is a daughter, a son, or other relative with income of her own but yet the taxpayer is still providing substantial support. In figuring out who provides more than half of the dependent’s support – the basic eligibility test for claiming the exemption – one looks to whether income of the dependent is or is not spent on her own support. So, for example, if the daughter is attending college and also at the same time working, any of her earnings that are spent on her support count towards her eligibility to take the personal exemption. Even though the student’s tax bracket most likely would be lower than the parent-taxpayer’s, any tax benefit certainly is better than the zero tax benefit the parent is getting because of the AMT.

Another example is in the case of divorced or separated parents, who may or may not have executed a multiple support agreement. The tax rules essentially allow the parties to agree which of them will take the child’s personal exemption. The planning here is simple, assuming lines of communication between the parties remain open – if one is in the Alternative Minimum Tax but the other is not, why not arrange to give the one not in the AMT the exemption deduction?

Posted in Personal Exemptions | 3 Comments »