# 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.

Annual election

The basic choice – itemizing vs. taking the standard deduction – is an election a taxpayer makes each year when the tax return is filed.  The election is binding for both the Regular Tax and the AMT; a taxpayer cannot itemize for one and take the standard deduction for the other.

Itemized deductions

The major categories of itemized deductions are Medical and Dental, Taxes, Charitable Contributions, Home Mortgage Interest, Casualty Losses, and Miscellaneous.  All of these are deductible under the Regular Tax.  Under the Alternative Minimum Tax, however, the itemized deduction categories of Taxes and Miscellaneous Itemized Deductions are disallowed in their entirety, while Charitable Contributions are fully allowed.  The categories of Medical and Dental, Home Mortgage Interest, and Casualty Losses also are allowed, at least in part.

Standard deduction

The standard deduction is a fixed dollar amount, adjusted annually for inflation.  This may be taken in lieu of itemizing deductions.  Currently this dollar amount is $11,400 for a married couple filing jointly.

Step 1 – compute the lowest Regular Tax

The Regular Tax, of course, is the starting point, and the choice here seems simple: if the standard deduction is greater than the taxpayer’s itemized deductions, then the standard deduction will result in a lower tax liability.  If the taxpayer is paying the Regular Tax, nothing more needs to be done.  If, however, the taxpayer is in the AMT, it is critical then to go to step 2 to avoid overpaying taxes.

Step 2 – recalculate the tax liability using itemized deductions

Going back to our married couple, even though their itemized deductions were less than the $11,400 standard deduction, they need to recalculate their taxes taking itemized deductions instead of the standard deduction.  Although this seemingly would increase their taxes, it may actually reduce their AMT, or even possibly even eliminate it as in the example discussed below.

Example

To illustrate how this analysis would work, assume a couple lives in Florida, a state with no income tax, and is renting their home so they have no real estate taxes or mortgage interest.  All the couple has for itemized deductions is $10,000 of charitable contributions.  They have $250,000 combined salaries and wages, and $50,000 of dividends and capital gains.

When this couple starts out with step 1, they note that their $10,000 of itemized deductions is less than the $11,400 standard deduction, so they elect to take the standard deduction.  At first blush, this seems to be the correct thing to do because their taxable income is $1,400 less by doing this than if they had itemized, but in actuality this would be a very costly mistake for them to make.

Under these facts the couple would pay $64,634 in taxes – $61,610 of Regular Tax and $3,024 of Alternative Minimum Tax.  Under the AMT, they receive no benefit from the standard deduction, and they are wasting the Alternative Minimum Tax benefit they could get from the $10,000 charitable contribution deduction.  If, instead, in this example the couple elected to itemize, their tax liability would be $62,072 – all Regular Tax, with no AMT.  Even though they gave us $1,400 in Regular Tax deductions, they saved $2,562 and completely eliminated the AMT!

Conclusion

It is critical that Alternative Minimum Taxpayers take this extra step.  At first it may seem counterintuitive to be taking the smaller of itemized deductions or the standard deduction, but thinking differently can actually end up saving significant taxes.

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!

A taxpayer has a choice of itemizing deductions or taking the Standard Deduction in computing his Regular Tax liability. The Standard Deduction is a fixed dollar amount that varies depends on filing status. In tax year 2009 it is $5,700 for Single and $11,400 for Married Filing Jointly – what we’ll call the base Standard Deduction.

State sales taxes paid in 2009 on the purchase of a qualifying new automobile can be added to the base Standard Deduction. Similarly, a limited amount of real estate taxes, and certain casualty losses, also may be added.

For purposes of the Alternative Minimum Tax, however, the base Standard Deduction is not allowed. But if the taxpayer was eligible to take a Regular Tax deduction for a casualty loss or for the new car sales tax in addition to the Standard Deduction, these items also are allowed for the AMT. The Form 6251 shows the AMT payer how to do this. Note also that if the Standard Deduction is chosen for Regular Tax purposes, it must also be used when calculating the AMT – it is a binding tax election.

The choice between itemizing and taking the Standard Deduction seems simple: if the total of a taxpayer’s itemized deductions is less than the Standard Deduction, then the Standard Deduction will result in less being paid. But this is not always the case when the Alternative Minimum Tax is involved. For AMT payers, there are certain situations where itemizing for Regular Tax purposes actually could lower the amount of AMT paid.

To illustrate, assume a taxpayer lives in Florida (no state income tax), rents instead of owns a home (no real estate taxes or mortgage interest), and didn’t make any taxable purchases this year (no sales tax deduction). But suppose this taxpayer also gave $10,000 to charity. The Standard Deduction for 2009 for joint return filers is $11,400, so this would appear to be the better choice. However, if the taxpayer were in the Alternative Minimum Tax there would be no benefit at all from the Standard Deduction, but there would be a benefit of up to $2,800 (the 28% Alternative Minimum Tax bracket times the $10,000 charitable contribution deduction) if itemizing is elected instead. Even the lower 26% tax rate would result in nearly the same benefit. So, somewhat counterintuitively, in this example opting to pay more Regular Tax will result in a lower overall tax liability.