Calculation of the AMT

Roth IRA Conversions and the Alternative Minimum Tax

Saturday, January 22nd, 2011 | Print 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 In exchange for paying taxes now, an individual will pay no taxes when the monies are withdrawn from the IRA.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 »

Just-Released Report of the Joint Committee on Taxation Provides an Overall Summary of the AMT

Wednesday, January 19th, 2011 | Print This Post | Email This Post

This summary of the AMT by the staff of the Joint Committee on Taxation was done in preparation for the first in a series of House Ways and Means Committee Hearings on Fundamental Tax Reform. With the Republicans taking control of the House, one of their major efforts this Congress will be taking a good hard look at our income tax system.

The excerpt from the report on the Alternative Minimum Tax:

An alternative minimum tax is imposed on an individual, estate, or trust in an amount by which the tentative minimum tax exceeds the regular income tax for the taxable year. The tentative minimum tax is the sum of: (1) 26 percent of so much of the taxable excess as does not exceed $175,000 ($87,500 in the case of a married individual filing a separate return) and (2) 28 percent of the remaining taxable excess. The taxable excess is so much of the alternative minimum taxable income (“AMTI”) as exceeds the exemption amount. The maximum tax rates on net capital gain and dividends used in computing the regular tax are also used in computing the tentative minimum tax. AMTI is the taxpayer’s taxable income increased by the taxpayer’s “tax preference items” and adjusted by redetermining the tax treatment of certain items in a manner that negates the deferral of income resulting from the regular tax treatment of those items.

The exemption amounts for 2011 are: (1) $74,450 in the case of married individuals filing a joint return and surviving spouses; (2) $48,450 in the case of unmarried individuals other than surviving spouses; (3) $37,225 in the case of married individuals filing separate returns; and (4) $22,500 in the case of an estate or trust. The exemption amounts are phased out by an amount equal to 25 percent of the amount by which the individual’s AMTI exceeds: (1) $150,000 in the case of married individuals filing a joint return and surviving spouses; (2) $112,500 in the case of other unmarried individuals; and (3) $75,000 in the case of married individuals filing separate returns or an estate or a trust. These amounts are not indexed for inflation.

Among the preferences and adjustments applicable to the individual alternative minimum tax are accelerated depreciation on certain property used in a trade or business, circulation expenditures, research and experimental expenditures, certain expenses and allowances related to oil and gas and mining exploration and development, certain tax-exempt interest income, and a portion of the amount of gain excluded with respect to the sale or disposition of certain small business stock. In addition, personal exemptions, the standard deduction, and certain itemized deductions, such as state and local taxes and miscellaneous deductions items, are not allowed to reduce alternative minimum taxable income.

Source: Present Law and Historical Overview of the Federal Tax System, JCX-1-11, January 18, 2011.

Posted in AMT Planning in General, Calculation of the AMT, Legislation/tax law changes | No Comments »

A Hidden Killer: the AMT Exemption Phaseout

Sunday, January 9th, 2011 | Print This Post | Email This Post

In computing the Alternative Minimum Tax, a taxpayer is allowed a certain “exemption amount,” similar in concept to the standard deduction and personal exemptions allowed in calculating the Regular Tax. A surprise that hits a lot of AMT payers, however, is that this exemption amount is gradually phased out as a taxpayer’s income increases. This “hidden killer” phaseout is one of the primary reasons folks get caught in the AMT.

The exemption amount

The AMT exemption amount for married taxpayers filing jointly is $72,450 for 2010 and for 2011, and it is set at different levels for other filing statuses (see Form 6251). The exemption amount was once again “patched” in the recently-enacted tax law, effectively indexing the amount for inflation.

How the exemption works

The exemption is a subtraction from a taxpayer’s Alternative Minimum Taxable Income (AMTI), before the tax itself is calculated. As an example, if a married-filing-jointly taxpayer’s AMTI before exemption were $120,000, after subtracting the exemption this taxpayer would apply the AMT rates only to the net number – in this example, $47,550. It would be highly unlikely that this taxpayer would pay the AMT after receiving the benefit of the full exemption.

The “hidden killer” phaseout

When the phaseout applies, however, the exemption amount becomes smaller, with taxable income thus correspondingly becoming larger. For married taxpayers filing jointly, the phaseout begins at the $150,000 income level, on a “1 to 4” basis. Specifically, for every $4 of additional income above this level, the exemption is reduced by $1. Note that, as with the exemption itself, the phaseout begins at different levels for the other filing statuses.

As an example, assume a married couple had AMTI before exemption of $160,000. In this case, the exemption would be reduced by $2,500 (1/4 of $10,000). If AMTI were $200,000, the exemption would be reduced by $12,500, and so on until it is fully phased out.

No indexing of the phaseout

One of the big problems with this hidden killer is that it has never been indexed for inflation. The last major rewrite of the tax law was in 1986, when the phaseout level was set at its current levels – $150,000 for marrieds filing jointly. Today it remains at those 1986 levels, despite the very obvious fact that $150,000 is a much more easily reached income level for married couples today that it was 25 years ago.

Those who are affected

The IRS’ recently-released statistics for the 2009 tax filing season reveal the problem. At income levels up to $100,000, fewer than 1% of taxpayers are in the AMT. For income levels between $100-200,000, this increases to 6%. After this comes the real shocker – at the $200,000 level up through $500,000, 70% of the folks in this group are paying the Alternative Minimum Tax. The hidden killer is one of the main reasons for this.

What this means, unfortunately, is that working families who are far removed from the super-rich whose abuses led to the imposition of the AMT over 40 years ago, are more and more being caught in its trap. President Obama himself refers to an income level of $250,000 to separate the rich from the not-so-rich, yet a large number of individuals below this level are in fact caught by the AMT.

What can be done

Much of AMT planning focuses on the itemized deduction side of the calculation, but the income side and its corresponding effect on the loss of the AMT exemption also is a critical issue in AMT planning. Some examples of tax planning opportunities that affect income levels include the basic question of whether or not both spouses should work, whether corporate executives should defer their bonuses to a future year or exercise their stock options, or whether small business owners should accelerate or defer income. There are many others that could apply to any individual taxpayer’s situation.

An online calculator is a must in doing any 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 Exemption, AMT Planning in General, Calculation of the AMT | No Comments »

Last-Minute AMT Calculations and Planning

Thursday, December 30th, 2010 | Print 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 »

The Alternative Minimum Tax: A Basic Understanding

Sunday, August 29th, 2010 | Print This Post | Email This Post

The Alternative Minimum Tax frequently is described as a “separate” or “parallel” tax system in an attempt to distinguish it from the “Regular” tax system that applies to all other taxpayers. But there really is only one tax system in the U.S. – our Internal Revenue Code – that applies to everyone. This article will illustrate how both the AMT and the Regular tax calculations follow the same common principles of taxation, as a useful starting point in understanding the individual AMT items that will be explored in future articles.

Here are the basic income tax concepts:

- we pay taxes on a number that we calculate that is known as “taxable income”
- we arrive at taxable income by adding up our various sources of income and then subtracting a certain allowable 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 then apply the appropriate income tax rate to our taxable income
- the result then is each of our individual shares of the national tax burden.

These basic concepts apply both for the AMT as well as for the Regular Tax, with differences in the individual components of the computations:

- on the income side, more is taxed under the AMT than under the Regular Tax
- on the deduction side, fewer are allowed under the AMT than under the Regular Tax.

The real “hit” from the AMT is that the tax that ultimately is due is the greater of the AMT or the Regular Tax. This is just the way the tax law works.

Most 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 and home equity lines of credit
- miscellaneous itemized deductions

The Regular Tax deductions that are allowed, but 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 more significant 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 each and every one of these AMT items. Each one is different, of course, but AMT planning generally can be grouped into the following categories:

- payment of expenses that are AMT items in one year versus another
- choice of a different investment strategy in terms of stocks, bonds, etc.
- choice of a different financing strategy when taking out a loan
- choice of a different business accounting method

Certain AMT items cannot be avoided (property taxes for homeowners, for example), but because income and deductions and tax rates do not remain static from year to year, the AMT frequently can be reduced simply by moving an AMT item like property taxes into a different year. Other AMT items may be eliminated in part or in full if they are covered by one of the other tax planning strategies listed above.

The essence of AMT planning is to 1) first determine which items are causing the taxpayer to fall into the AMT, and then 2) take the appropriate action to lessen, if not eliminate, the effect of each item. All of the AMT-reducing planning opportunities will be individually explored in future articles.

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

AMT Case Study: Vice President Biden’s 2009 Tax Return

Monday, May 31st, 2010 | Print This Post | Email This Post

As has become customary, the President and the Vice President have released their recently-filed tax returns. You can find these tax returns on the White House blog by doing a search for “tax returns,” or by clicking on this link: http://www.whitehouse.gov/blog/2010/04/15/president-obama-and-vice-president-biden-s-tax-returns.

An interesting thing to note is that Vice President Biden remains stuck in the Alternative Minimum Tax, as he has been for at least the past several years. As we have been discussing in recent articles, the combination of the AMT exemption phaseout along with his itemized deductions is what ensnares him in the AMT trap. The VP’s total income was just over $300 thousand, certainly not in the “rich” category by today’s standards for a couple with two incomes. President Obama, with income in excess of $5 million, didn’t even come close to paying the AMT.

Let’s review what we have been talking about in the last few articles, using the Vice President’s return as a case study. The reader is encouraged to look at the Bidens’return as we go through this analysis.

AMT exemption phaseout

The VP’s Alternative Minimum Taxable Income (“AMTI”) was $298,013, right in the middle of the AMT exemption phaseout range of $150,000 to $433,800 (see the May 8th article on the AMT exemption). So instead of getting his full AMT exemption of $70,950, he was limited to an exemption of $33,947. Was he starting to hear the AMT sucking sound at this point? You bet he was.

Itemized deductions – state income tax

The Vice President’s state of residence is Delaware, one of the majority of states that has an income tax. As can be seen in his tax return, he made a total of $17,718 in state tax payments in 2009 through a combination of withholdings from his and his wife’s wages as well as prior year estimated payments. This amount properly was deducted for Regular Tax purposes, as can be seen on his Schedule A – Itemized Deductions.

As it turned out, however, Biden was significantly overpaid – more than was required to meet his obligation to the state of Delaware. The overpayment of $4,749 is seen on his Delaware state tax return also shown on the White House web site along with the Federal return.

AMT impact from state income tax overpayment

The $4,749 overpayment by itself resulted in $1,567 in AMT. Since this means zero in Federal tax benefit because the AMT allows no deduction for taxes, this was a wasted deduction. Had the VP done some basic AMT planning, he would have been better off paying this in 2010 as part of his 2010 Delaware taxes.

Also, as was discussed in the May 17th article on state income taxes and the AMT, Delaware tax law only requires that 90% of an individual’s income tax needs to be paid in by December 31 in order to avoid a penalty. Adding this 10% to the actual overpayment means that he paid another $470 in 2009 Alternative Minimum Tax that did not have to be paid.

Note also that the Vice President’s overpayment of Delaware taxes will be an AMT item – this time in his favor – on next year’s 2010 return. Such refunds are income for Regular Tax purposes but are not for the AMT because of the absence of an AMT benefit having been received in the prior year.

Itemized deductions – property taxes

We cannot tell from the VP’s income tax return when he received his property tax bill or when it was paid, but this is another area of potential AMT savings. As explained in the May 21st article on property tax planning, a taxpayer’s possible control over paying a property tax bill in December or in January is a factor with direct impact on the amount of Alternative Minimum Tax paid. Refer to that article for a specific example of how this works.

AMT planning

Will the Vice President ever be able to get completely out of the Alternative Minimum Tax? While we don’t have the information to know the answer to that question, there certainly are enough opportunities, as discussed above, for him easily to at least reduce the amount of AMT that he is paying.

Conclusion

Even though this Memorial Day weekend officially opens barbecue season, and we now have other summertime distractions like golf, tennis, or just taking some time off for a well-earned vacation, it soon may be too late to adjust state tax withholdings and to make other needed changes if you don’t start giving your 2010 AMT situation a little early thought.

Posted in Calculation of the AMT, State Income & Other Taxes | 1 Comment »

Calculation of the Alternative Minimum Tax – Property Taxes

Friday, May 21st, 2010 | Print This Post | Email This Post

Similar to state income taxes, for Regular Tax purposes you are allowed a deduction for property taxes that you pay. Under the AMT, however, you are allowed no deduction for property taxes. This problem affects more than 90 percent of all folks stuck in the Alternative Minimum Tax, so it is something that you definitely need to look at.

Property tax assessment and billing cycles vary among the states, but the basic concept of your control over paying a tax bill in December or in January – as we previously discussed regarding state income taxes – also applies to property taxes.

Real estate taxes

As an example, here is a sample of an actual property tax bill 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. With this example we can see how easy it is to have a direct impact on the AMT you pay.

Assessed value		$500,000
Total property tax rate		1.0724%
Property tax due		$5,362
Due date		12/31/10

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	(no discount)
“	1/31/11	“	5,630	(5% penalty)
Paid after	1/31/11	“	6,488	(21% penalty)

The AMT-saving strategy for property taxes is extremely simple here, since you have a choice of paying your property taxes in 2010 or in January, 2011. 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 property tax deduction in a year you are in the AMT. By paying your property taxes paid in a year you are not in the AMT, you will achieve real tax savings.

In this example, if you are in the AMT this year but do not expect to be in the AMT in 2011, by waiting until January to pay this bill you will save up to 35% in Federal income taxes (39.6% if the “Bush tax cuts” are allowed to expire). This obviously is much greater than the 2% discount you will forego and the 5% penalty you will incur.

Each individual reader’s state assessment and billing cycle will vary from this example, but the concept is the same – to the extent you can, without incurring penalties with which you would not be comfortable, control even a portion of the timing of payment of your property taxes, you can save on your AMT bill.

Personal property taxes

Many states impose taxes on the value of personal property that is owned. 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.

Assume your personal property tax rate is 1.5%, for example, and you have a $40,000 car. Your tax will be $600. If you have the opportunity to pay this in one year versus another (the December – January example above), this could be an easy way to shave a few hundred dollars off your AMT bill.

Conclusion

Property taxes represent one of the easiest AMT planning opportunities. It is not hard to take a quick look at last year’s property tax bills to see when they were received and when they are payable. A little advance planning right now potentially can save thousands in taxes if the AMT is taken into consideration when paying these bills.

Posted in Calculation of the AMT, State Income & Other Taxes | No Comments »

Calculation of the AMT – State and Local Income Taxes

Monday, May 17th, 2010 | Print This Post | Email This Post

Every state with an income tax requires that you pay the tax throughout the year, just as the IRS does. This is done either through withholding from your paycheck – if you are an employee – or through quarterly estimated payments if you are self-employed, retired, or you are an employee but have not increased your withholding to cover the taxes you will owe on your investment income.

If you are stuck in the AMT, you are getting no benefit from your state income taxes paid – they simply are disallowed as a deduction in computing the Alternative Minimum Tax. But if you could move some of your deductions to a year when you are not in the AMT, you could achieve real tax savings – up to the 35% depending on your tax bracket.

Essentials of state tax payments

There are two essential things to remember in planning your state income tax payments in order to reduce your AMT

One is that 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 minimum required amount you may be subject to an underpayment penalty, which usually is calculated in a manner similar to interest.

Second is that if you make quarterly estimated tax payments, the fourth quarter payment generally is 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.

Control over that last portion of state taxes due

Remembering the above key facts, the AMT-saving strategy is to look at the control you have over the payment of this last portion of your state taxes – the fourth quarter installment, if applicable, and/or the last 10 or 20 percent you will owe. Since you have the choice of paying a portion of your state income taxes either in December of the current year, or in January or even April of the following year, the decision on when you write out the check to pay these taxes will have a direct impact on the AMT you will pay.

By having more of your state income taxes paid in a year when you are not in the AMT, you will achieve real tax savings.

An example

To illustrate how this works, assume that you expect to be in the AMT in 2010, that your total 2010 state taxes will be $15,000, and that you expect not be in the AMT in 2011. If you could defer paying just 10% – $1,500 – of your 2010 state income tax until 2011, this could save you $500 or more depending on your tax bracket. If you could defer $3,000, your savings would be over $1,000, and so on. Note that even if you do 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. With the Democrats pushing for higher income tax rates, this becomes more and more a real possibility.

What you need to do to evaluate this AMT-saving strategy

Check on your state’s web site to determine the minimum percentage of your taxes that have to be paid in by December 31. It likely is 80% or 90%. Also check the rules for estimated payments and the forms that you will need to do this. Then, using an AMT planning model like that available on amtindividual.com, try putting different numbers in the model for your state tax payments, and you quickly will see how much you might be able to save by reducing your AMT.

Good luck with your planning!

Posted in Calculation of the AMT, State Income & Other Taxes | No Comments »

Impact of Itemized Deductions on the Alternative Minimum Tax

Thursday, May 13th, 2010 | Print This Post | Email This Post

In previous articles we talked about the different tax brackets for the Alternative Minimum Tax and the Regular Tax, and the AMT exemption and how its phase-out throws a lot of people into the AMT. This was a review of the income side of the AMT calculation – i.e., how a taxpayer’s income level can act like a vortex pulling him into the AMT. Now we are shifting gears and addressing the deduction side of the calculation.

Itemized deductions

The bulk of the AMT problem actually comes from the deduction side – specifically, deductions that an individual is allowed to take in computing the Regular Tax but is not allowed to take for the AMT. Of the different types of deductions, some are not allowed at all for the AMT, while others are allowed but to a lesser extent than they are allowed for the Regular Tax.

The deductions that are allowed for the Regular Tax but are not allowed at all for the Alternative Minimum Tax are the following:

- the deduction for state and local taxes

- miscellaneous itemized deductions

- the standard deduction

- the deduction for personal exemptions

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

- the itemized deduction for medical and dental expenses

- the deduction for interest paid

- many business expenses such as depreciation, depletion, and research expenses, among others

State and local taxes affect more than 90% of all AMT payers

Of the deductions listed above, the single one that impacts almost every individual caught in the AMT trap is the deduction for state and local taxes. These are relatively large dollar items for most taxpayers, and, as mentioned above, they are not deductible at all for the AMT.

The term “state and local taxes” includes the following:

- State income taxes. Forty-three states impose a state income tax, and some of them – New York and California come to mind along with numerous others – have fairly high tax rates for folks who are at the income levels already being affected by the AMT. (Residents of the following states are the lucky ones who do not share this burden: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.)

- Local income taxes. Many cities across the United States impose their own income taxes. New York City, of course, has one, and other cities across the nation – Louisville, Kentucky is one other example – also have them. New York City’s tax rate ranges from 2.9% to 3.6% of taxable income, while Louisville’s is 2.2% on gross earned income – no deductions allowed. Taxes like these quickly compound the AMT problem.

- Real estate taxes. Owners of real estate pay property taxes on the value of the property (an “ad valorem” tax). Many states – you know if you live in one – have high property taxes. Again, a big AMT problem.

- Personal property taxes. It is not uncommon for states and local jurisdictions to impose a property tax on personal property. “Personal” is a legal term meaning tangible but moveable property such as cars and boats. Check the tag renewal notice on your car, for example, to see how much this is.

- Sales taxes. All states but six impose a sales tax. On the Federal return the taxpayer has an option to deduct state and local sales taxes in lieu of income taxes. In the seven states with no income tax this election generally proves beneficial in computing the Regular Tax – but of course it is no help when it comes to the AMT.

In the next article we’ll look at the effect these lost itemized deductions have on calculation of the AMT, and we also will review the significant tax planning opportunities that they present.

Posted in Calculation of the AMT, State Income & Other Taxes | 1 Comment »

Taxable Income, Tax Brackets, and the AMT Exemption – Part II

Saturday, May 8th, 2010 | Print This Post | Email This Post

In Part I, we discussed the different tax brackets for the Regular Tax and for the Alternative Minimum Tax, as well as the AMT exemption. For 2009 for married couples filing jointly (MFJ) the AMT exemption was $70,950. In this article we will discuss the phase-out, or loss, of the exemption as taxable income exceeds a certain threshold level. For MFJ, this taxable income threshold is $150,000. The Form 6251 also has the thresholds for the other filing statuses, found at this URL: http://www.irs.gov/pub/irs-pdf/f6251.pdf.

The AMT exemption phase-out

As taxable income increases above $150,000, the AMT exemption amount decreases. A taxpayer loses $1 of exemption for every $4 increase in taxable income. Thus, for example, if taxable income before exemption is $250,000 ($100,000 over the threshold), $25,000 of the AMT exemption is lost. All other things being equal, in this example AMT taxable income would be $275,000 even though Regular Tax taxable income would be $250,000 – making it likely you would find yourself stuck in the AMT.

Note that this phase-out formula means your AMT taxable income increases at a more rapid rate – 25% faster – than any increase in your Regular Tax taxable income. This acceleration is a significant part of what pulls individuals quickly into the AMT.

Dividends and capital gains

Under current law, dividends and long-term capital gains are taxed at a lower bracket – typically 15% – for both the Regular Tax and for the AMT. In theory, using this same bracket prevents dividends and capital gains from triggering the AMT.

Unfortunately, however, dividends and capital gains are included as part of taxable income, so they, like all other income, have a direct impact on an individual’s AMT because of the extra 25% effect discussed above. It’s easy to be fooled by this one.

Beyond the AMT exemption phase-out

For taxpayers who make “a lot” of money (defined below), the AMT rapidly becomes much less of a concern. There are two forces at work here as income gets into higher levels:

First is that the AMT exemption phase-out simply stops at a certain point. For MFJ, the phase-out stops at taxable income of $433,800. At this point, the $283,800 of income over the initial $150,000 means (at the 4-to-1 ratio described above) the $70,950 exemption is completely gone ($70,950 times 4 equals $283,800). After this, AMT income grows at the same rate as does Regular Tax taxable income, so the 25% penalty no longer applies.

Second is that, at this level of income, the taxpayer now is paying Regular Tax at a significantly higher bracket than the AMT bracket. Looking at the above tax bracket schedules, one can see that the taxpayer now is well into the 35% Regular Tax bracket, leaving far behind the maximum 28% AMT bracket. Remembering that a taxpayer pays the greater of the Alternative Minimum Tax or the Regular Tax, at these levels of income it is unlikely the taxpayer will be in the AMT.

Summary

Once a MFJ couple exceeds the $150,000 taxable income level, the sucking sound of the AMT vortex pulls them in at a rapidly-increasing rate. But for the wealthy – ironically, those at whom the original Minimum Tax was aimed when it was first enacted over 40 years ago – they can safely sit on the sidelines and not even be concerned. This is why, in the tax returns disclosed in the 2008 Presidential campaign, we saw that Joe Biden, John McCain and Sarah Palin – each making in the neighborhood of $250,000 – all were caught in the AMT trap, while President Obama with his millions from book royalties was not even touched by it.

Next – itemized deductions as the major difference between Regular Tax taxable income and AMT taxable income.

Posted in AMT Exemption, Calculation of the AMT, Capital gains & Dividends | No Comments »