AMT Planning in General

The Estate Tax and the AMT – An Urgent Concern for Taxpayers

Wednesday, March 3rd, 2010 | Print This Post | Email This Post

As we sit today, we do not have an estate tax in 2010. The problem this presents is that, through an interplay of the estate tax rules and the Alternative Minimum Tax rules, if Congress does not act to reinstate the estate tax for 2010 there will be a significant increase in the number of individuals paying the AMT, not only in 2010 but in all future years as well.

The AMT issue

The AMT side of this issue stems from the impact that capital gains have on an individual taxpayer’s AMT. While long-term capital gains are taxed at the same tax rates for both the Regular Tax as well as the AMT, an increase in an individual’s taxable income, whether from ordinary income or from capital gains, in many cases means a decrease in the individual’s AMT exemption amount.

Here is how this works: once a certain level of Alternative Minimum Taxable Income (AMTI) is reached, every dollar of additional income will reduce the taxpayer’s exemption by 25 cents. The threshold level for a married couple filing jointly is $150,000; it is lower for singles and marrieds filing separately. These thresholds, as well as the mechanics of the AMT exemption phaseout, are explained in the lower part of the IRS Form 6251.

The estate tax issue

Here is the estate tax issue: capital gains are the excess of the selling price of a capital asset, such as a security, over the taxpayer’s basis in that security. The most common concept of basis is what the taxpayer paid for the security when he bought it. For example, a share of stock purchased for $100 will have a tax basis of $100; if it is later sold for $120, the taxpayer has a capital gain of $20 on which he will pay tax. But in the case of inherited securities the determination of basis is very different.

So long as the estate tax is in effect, a beneficiary receives a tax basis in any inherited property equal to its fair market value on the date of death. In the vast majority of cases, this is a “stepped-up” basis because, over time, stocks generally appreciate. This is especially the case for senior citizens because they generally have a long-term hold strategy. All of this means that a decedent’s tax basis typically is well below a stock’s current price. In the above example, that share of stock worth $120 may have been acquired by the decedent for $50, or even less.

The two rules together

With the estate tax in place, if the decedent passes away when that stock is worth $120, that amount is now the tax basis for the heir when the shares are distributed to him. Thus, if the heir sells it for $120, he has zero gain to pay tax on, and this has zero effect on his AMT exemption amount.

Suppose, however, the estate tax is not put back in place. In this case the heir’s tax basis in the above example is $50 because he receives a “carryover” basis instead of a stepped-up basis, and a sale at $120 would result in a $70 capital gain. If the individual has AMTI over the specified threshold, this $70 gain on each share of stock sold would decrease his AMT exemption by $17.50 (25% of the gain). If enough shares are sold, this could have a significant and direct impact on the individual’s Alternative Minimum Tax liability.

Summary

Warren Buffet and Bill Gates are long-standing advocates for the estate tax. While these two probably are not AMT payers, every one of the 4.3 million individuals currently subject to the Alternative Minimum Tax, as well as all other taxpayers who are at risk of being drawn into the AMT, should be right there joining these two in advocating reinstatement of the estate tax!

Posted in AMT Exemption, AMT Planning in General, Legislation/tax law changes, Other issues | No Comments »

The Alternative Minimum Tax: Basics of What You Need to Know

Sunday, February 14th, 2010 | Print This Post | Email This Post

The Alternative Minimum Tax often is described as a “separate” tax system or a “parallel” tax system, separate and distinct from the “regular” tax system that applies to everyone. While the AMT creates a unique fraternity with a membership of over four million out of a total taxpayer population of over 150 million, there really is only one tax system in the U.S.

Our tax system is complicated, but the underlying concept is basic:

- we pay taxes on a calculated number that is known as “taxable income”
- we arrive at taxable income by adding different sources of income and then subtracting a certain number of deductions
- not all income is subject to tax
- little of what we spend each year may be taken as a tax deduction
- we apply the appropriate tax rate to our taxable income
- the result is our individual share of the national tax burden.

This same concept applies for the AMT as it does for the Regular Tax, but the individual components of the computation are different:

- more income is taxed under the AMT than it is under the Regular Tax
- fewer deductions are allowed under the AMT than under the Regular Tax.

The key to remember is that, under these alternative computations, the tax that will be due is the greater of the AMT or the Regular Tax. While this may not seem fair, and in many cases it isn’t, that’s just the way it is. One has no choice.

The bulk of the AMT “hit” comes from the deduction side – deductions that an individual is allowed to take for the Regular Tax but is not allowed to take for the AMT. Some deductions are not allowed at all for the AMT, while others are allowed, but to a lesser degree. The Regular Tax deductions that are not allowed at all for the AMT are:

- the standard deduction
- the deduction for personal exemptions
- the itemized deduction for state and local taxes
- interest on certain second mortgages or home equity lines of credit
- miscellaneous itemized deductions

The Regular Tax deductions that are allowed to a lesser extent for the AMT are:

- the itemized deduction for medical and dental expenses
- many business expenses such as depreciation, depletion, and research expenses, among others

On the income side, there are fewer differences. The key ones are:

- tax-exempt bond interest that is from a “private activity bond”
- income from the exercise of an “incentive stock option” (“ISO”)
- state income tax refunds

It is important to note that tax planning opportunities exist for all of these AMT items. Each one is different, of course, but the planning generally falls into the following groupings:

- paying certain expenses that are AMT items in one year versus another
- choosing a different accounting method
- altering an investment strategy
- altering a financing strategy

Certain AMT items cannot be avoided in their entirety (property taxes, for example, at least while one owns a home), but because income and deductions and tax rates do not remain static from year to year, the AMT almost always can be reduced in part by moving the AMT item into a different year. Other AMT items, however, may be eliminated in part or in full if they are covered by one of the other tax planning strategies listed above. Thus, the essence of AMT planning is 1) first determining which items are causing the taxpayer to fall into the AMT, and then 2) taking the appropriate action to lessen, if not eliminate, the effect of each item.

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

Alternative Minimum Tax Planning for 2009 – What Still Can be Done Even Though We are in 2010

Thursday, January 14th, 2010 | Print This Post | Email This Post

With the turning of the calendar to 2010, many of the opportunities for 2009 AMT planning are gone. This article will provide a brief overview of the AMT strategies that still are available for 2009, as we sit today, and some of these will be explored in more detail in future articles. Many of these items are somewhat narrow in scope, but if just one applies to a particular taxpayer’s situation, it definitely can serve to reduce an AMT bill that otherwise would be due in April.

Depreciation – Rental property and property used in a business may be depreciated. The law allows a taxpayer to choose among several depreciation methods, and this choice is not made until the tax return is filed. Some depreciation methods result in an AMT item while others do not.

Depletion – A taxpayer investing in oil & gas or other mineral properties may take a deduction for his investment in a manner similar to depreciation. Also similar to depreciation, some depletion deductions are AMT items while others are not. This choice is made when the tax return is filed.

Intangible drilling costs and mining costs – The same as depreciation and depletion above, certain cost-recovery methods for these types of investments, which are chosen at tax return time, can trigger the AMT.

R&D – Research and development costs incurred by a business may be deducted currently instead of being amortized over time, resulting an AMT item. If the business is an LLC, partnership or S corporation, this AMT item will be reflected on the taxpayer’s individual Form 1040. The choice of deduction is made at tax return time.

Circulation costs; long-term contracts – Certain types of businesses receive more beneficial treatment of deductions for the Regular Tax than for the AMT, resulting in AMT items. Similar to the R&D, the AMT effect depends on the type of business entity. The choice of deduction is made at tax return time.

Incentive Stock Options (ISOs) – ISOs receive very favorable Regular Tax treatment at the time of their exercise – they simply are not taxed at that time. Instead, assuming the numerous ISO requirements are met, income from these options is not taxed until the underlying stock is sold at a later time. At that point, the income is taxed at favorable long-term capital gain rates instead of ordinary income Regular Tax rates. Under this normal scenario, an AMT item is triggered on the date of exercise. However, a taxpayer has until one year after date of exercise to “disqualify” the options, resulting in ordinary income but also completely eliminating the AMT item. A future article will discuss in some detail this “disqualification” concept as an AMT-planning strategy.

Posted in AMT Planning in General | 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 10

Sunday, December 27th, 2009 | Print This Post | Email This Post

Year-End AMT Planning Wrap-Up – Part 1

In our 10-week series of articles on tax planning for the Alternative Minimum Tax, we have looked at many things a taxpayer can do to reduce his AMT liability. With only four days left in which to act in order to reduce 2009’s taxes, here is a summary of these items, with reference to the date each article appeared on amtblog.com. Please refer back to the article for the specific tax-saving steps that still may be taken before year end.

State and local taxes

This item affects 94% of all AMT payers, yet it is one of the easiest to plan for and it can have the most direct impact on a taxpayer’s Alternative Minimum Tax. There are three types of taxes here:

1. Property taxes – by weighing the relative factors of property tax burden, percentage of AMT payers, and size of population, here is a ranking of the top 10 states that are hit the hardest by this item. Residents of these states really do need to focus on this one in particular. See the November 8th article posted on amtblog.com, “Property Taxes.”

#1 – New York
#2 – New Jersey
#3 – California
#4 – Illinois
#5 – Massachusetts
#6 – Connecticut
#7 – Maryland
#8 – Pennsylvania
#9 – Virginia
#10 – Ohio

2. Income taxes – the tax dollars here are larger, on a per-taxpayer basis, than property taxes. While the AMT planning takes a little more work than property taxes, the potential savings still are there. See the amtblog.com article posted on November 2nd, “State Income Taxes.”

3. Sales tax on new cars – this is easy money for those who bought a new car this year, or still are contemplating buying one. See the amtblog.com article posted on November 11th, “Sales Tax on New Cars.”

Stock options, in particular Incentive Stock Options (ISOs)

A large number of corporate employees, generally ranging from the mid-management level up to the “C Suite” folks, have stock options granted to them by their employers. If these options are ISOs, AMT planning is critical because of the major impact the exercise of these options can have on an individual’s Alternative Minimum Tax. Our two-part series of articles appearing on amtblog.com on December 3rd and December 6th, “Incentive Stock Options – Parts 1 and 2,” go through the basic steps in determining whether a taxpayer does in fact have an ISO – often confused with the other types of stock options and equity grants an employer may offer – and then explains how these ISO exercises trigger the AMT. This is a very important read for all those who either have exercised stock options or are contemplating exercising stock options.

Capital gains

The impact of capital gains on a taxpayer’s Alternative Minimum Tax can be a real surprise – and, unfortunately, not a pleasant surprise At first blush capital gains appear to be AMT-neutral, but this is far from the case. The December 13th article on amtblog.com, “Investments – Capital Gains,” explains this issue. To the extent a taxpayer has recognized capital gains in 2009, and/or “harvested” capital losses to offset capital gains, there can be a direct AMT impact. Any capital gain or loss activity between now and December 31 also will have this impact.

Summary

It is not too late to take action on any of the above items for 2009, but time is short. Once the ball drops in Times Square, you’ll be planning for 2010!

Posted in AMT Planning in General, Capital gains & Dividends, Incentive Stock Options Exercised, State Income & Other Taxes | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 1

Saturday, October 31st, 2009 | Print This Post | Email This Post

“It’s the time of the season” was a popular song some years ago. The barbecue grills are put away, the kids are back in school, and the foliage is starting to turn. The 2008 tax return season was officially over on October 15; now it’s time to start thinking about 2009.

With only two months to go, do you know yet whether you’ll owe more taxes in April or be getting a refund? Do you know that you have the opportunity – now – to make your refund bigger or the check you write the IRS smaller? All it takes is brief look at your tax situation and consideration of what you can do in the next 60 days. If you wait until January it’s too late to lower your 2009 taxes.

This is especially true for those of you stuck in the Alternative Minimum Tax. For AMT payers, there is quite a list of things you can do to reduce your AMT bill, and all of them are very simple.

Over the next two months we’ll be doing a series of articles on what these things are, but here is just 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 state income taxes. If you are in the AMT in 2009 and pay these taxes in 2009, you will get zero tax benefit. If you wait until January to pay the $5,000, and then are not in the AMT in 2010, you will achieve a tax savings from the IRS of up to $1,750.

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.”

George Bauernfeind is with AMTIndividual.com, providing analysis, customized strategies, and an online dual tax calculator / planner to help you reduce your Alternative Minimum Tax.

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

AMT 101

Friday, May 22nd, 2009 | Print This Post | Email This Post

It’s a pretty safe bet to say that the vast majority of folks do not have an understanding of the Alternative Minimum Tax. In this next “mini-series” of articles we’re going to try to give you just an outline of it, not a full-semester course as our title would indicate. This is an “audit” class only – there will be no exam at the end!

The AMT is often referred to as a “parallel” tax system, separate and distinct from what we’ll call the “regular” income tax. For the first hundred years of our income tax – since the Revenue Act of 1861, enacted to finance the Civil War – to the Tax Reform Act of 1969, U.S. taxpayers have had only one way to compute their annual income tax liability. For the past 40 years, however, we have had to do it two ways – with the privilege then of paying the higher of the two!

Calculating a tax liability essentially is simple math. We start by adding up a bunch of numbers representing the income we have earned during the year. This includes wages from our W-2s, interest, dividends, capital gains, and “all other income from whatever source derived,” to quote from the Internal Revenue Code. From this total we then subtract “deductions allowed by this chapter” to arrive at “taxable income.”

Code section 1: “There is hereby imposed on the taxable income of every individual a tax determined in accordance with the following tables….” The tax tables we use vary, depending on our “filing status” – single, married filing jointly, married filing separately or head of household.

So what’s different about the AMT?

The AMT follows the same basic math, but the big difference is what is included in the definition of “income” (it is more inclusive), and what deductions are “allowed” (fewer are allowed). AMT taxable income thus is, with very rare occasion, higher than our regular tax taxable income. In addition, the AMT has its own tax table, separate and distinct from the four listed above.

In our next article, we will give some examples to show how this works.

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

Obama and Biden release tax returns – Vice President still stuck in the AMT

Friday, April 24th, 2009 | Print This Post | Email This Post

Last week President Barack Obama and Vice President Joe Biden released their 2008 income tax returns. The President is not paying the AMT, but the Vice President is still stuck in it, as he has been for several years. We had seen this when they made their tax returns public during the presidential campaign.

Biden’s income is in the “wealthy” category, as defined by the President – those making over $250,000. But with total income of $269K, just barely over that threshold, it may seem odd that he would be subject to the AMT. Unfortunately, our VP’s situation once again confirms that the AMT in its current form is not in any way related to the original AMT enacted 40 years ago. It continues to hit “ordinary” Americans working hard for a living who just happen to be caught in its “sweet spot.” And that sweet spot continues to grow – currently over 4 million taxpayers and counting.

Why is Biden in the AMT but Obama is not? As we’ll see in future articles, he is making just enough income, and has just the wrong level of itemized deductions, and it is the interplay of these two that does it. The President, on the other hand, with his substantial book royalties, had nearly $3 million of income, at which level the “regular” tax is higher than the AMT.

Is there anything the VP can do about this? Of course there is – nearly everyone can reduce his/her AMT liability. In Biden’s case, his focus should be timing his deductions better. Especially with higher tax rates on the horizon – remember that rich people like him will soon be paying the promised higher taxes – the VP could save taxes by doing some simple planning. All this would take is a little modeling with a tax software program to see how tweaking his deductions could have a direct impact on his AMT.

The tax returns can be found on the White House web site – www.whitehouse.gov.

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