Calculation of the AMT

How Can I Get Out of the AMT this Year?

Wednesday, May 5th, 2010 | Print This Post | Email This Post

So the Alternative Minimum Tax bug bit you again in 2009. You sit there looking at your tax return trying to figure it out. Is there a way to avoid the AMT, or are you stuck in it for life? The calculations are confusing, yet there are some basic themes underlying all of it that seem to be pushing certain taxpayers into the AMT. What are these themes, and is there a way to understand how they, and the accompanying calculations, actually work?

Through the month of May we will be publishing a series of articles explaining these themes and these calculations. Your accountant may have closed up shop for the summer, or you simply may be tired of paying tax return preparation fees without seemingly accomplishing anything. A little self-help on your part at this time of the year will go a long way toward understanding what happened to you in 2009 and what you can do about it for 2010.

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

This article and the next one will look at the basic calculations – the income tax brackets that apply for the Regular Tax, as compared to the AMT, and the AMT exemption and its phase-out and the effect this phase-out has on the computation of the Alternative Minimum Tax.

Taxable income – the starting point

While every taxpayer is different, each of us has a threshold level of income that will trigger the AMT. What we are talking about is taxable income, which in simple terms is all of your income less all of your allowable deductions. As a separate but parallel tax system, the Alternative Minimum Tax has different rules on what items of income must be included, and on what deductions are allowed in computing taxable income. These differences will be explored in future articles.

Once taxable income is computed, one then looks to the tax bracket tables to compute the tax liability.

Tax brackets – the Regular Tax

Here are the 2009 Regular Tax brackets for a couple electing Married Filing Jointly (MFJ). These and the tax brackets for the other filing statuses may be seen in the Form 1040 instructions, on page 101, found at this URL: http://www.irs.gov/pub/irs-pdf/i1040.pdf.

Taxable Income		Tax Bracket

Up to	$16,700	10%
Over	16,700	15%
Over	67,900	25%
Over	137,050	28%
Over	208,850	33%
Over	372,950	35%

Tax brackets – the Alternative Minimum Tax

The AMT has one set of brackets, applying to all filing statuses. Unlike the Regular Tax brackets, they are not indexed for inflation, so they remain constant unless Congress changes them. These brackets can be seen on the Form 6251, found at this URL: http://www.irs.gov/pub/irs-pdf/f6251.pdf.

Taxable Income		Tax Bracket

Up to	$175,000	26%
Over	175,000	28%

The AMT exemption

The AMT exemption for 2009 for MFJ is $70,950. The exemption levels for the other filing statuses may also be found on the Form 6251 at the URL shown above. The purpose of the exemption is to prevent taxpayers at lower levels of income from being pulled into the AMT.

For a simple example, refer in the above Regular Tax table to a couple with taxable income of $67,900. The couple’s Regular Tax liability on this income would be $9,350, with the first $16,700 being taxed at 10% and the balance at 15%.

If there were no AMT exemption, this couple’s AMT would be $17,654 because the full $67,900 of taxable income would be taxed at the AMT’s 26% bracket – far in excess of the 10% and 15% Regular Tax brackets. With the AMT exemption, however, this couple’s taxable income for Alternative Minimum Tax purposes is zero, so they have no concerns about the AMT.

Summary

The above illustrates the basic calculations behind the Alternative Minimum Tax and the importance of the AMT exemption. But a provision that affects the amount of the exemption as a taxpayer’s income increases – the “phase-out” of the exemption – will be explored in the next article – Part II.

Posted in AMT Exemption, Calculation of the AMT | No Comments »

Standard Deduction or Itemized? The AMT Requires Additional Analysis

Tuesday, April 6th, 2010 | Print This Post | Email This Post

A common question that arises at tax time is whether to itemize or take the standard deduction. For individuals paying the Regular Tax the decision is easy, but when the AMT is involved there is one extra step that needs to be taken. As will be seen in the example below, this step can save the taxpayer thousands in AMT dollars.

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.

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

Who Has to File the Form 6251?

Sunday, March 21st, 2010 | Print This Post | Email This Post

A common question that is asked is who has to file the IRS Form 6251, “Alternative Minimum Tax – Individuals.” The answer seemingly is simple – those who have to file the Form 6251 are those who owe the Alternative Minimum Tax. If a taxpayer does not owe the AMT, the 6251 does not need to be attached to the Form 1040. But how does a taxpayer know if he owes the AMT? There are several different ways to approach this; these are discussed below.

1. Fill out the Form 6251

Each and every taxpayer is responsible to determine the taxes he owes, so he alone is responsible to test for the AMT. Filling out the form is one sure way to do this; if the AMT is not owed, the form simply can be discarded. But with the IRS estimating that it takes 21.4 hours on average to complete the Form 1040, including recordkeeping and other requirements, why add to this burden if there is any way around it?

2. Fill out the worksheet located in the Form 1040 instructions

The IRS has plenty of instructions. The 2009 version of the basic Form 1040 instructions is 175 pages long, and buried in among all that good knowledge is a worksheet to help taxpayers determine of they owe the AMT (for 2009 it is located on p. 41). But this worksheet is of limited assistance because it focuses only on the basic computation, and whether a taxpayer’s itemized deductions or the phaseout of the AMT exemption is what is triggering the AMT.

What the worksheet does not do is help a taxpayer who has any of the 17 AMT items and credits that are listed there. If a taxpayer has any one of these, he is told to “fill in Form 6251 instead of the worksheet.”

3. Go to the IRS web site and check out its “AMT Assistant.”

This is a handy little tool, but again is of limited utility because it simply is an electronic version of the worksheet found in the Form 1040 instructions. If a taxpayer has none of the 17 items, this can save him from having to do the actual calculations himself. But if the taxpayer has any one of the items, it’s back to the Form 6251.

4. If I didn’t pay it last year then I don’t owe it this year (also known as the “head in the sand” approach)

It’s probably fair to say that it is not anyone’s idea of fun to fill out IRS forms, especially if it is not necessary to do so. So one approach is that, if the taxpayer did not owe the AMT last year, and assuming no big changes in income or deductions this year, the odds are that the AMT won’t be due again this year. But for some taxpayers it doesn’t take much of a fluctuation in income or deductions to get caught in the AMT. Another problem is that this approach fails miserably if Congress does not once again extend the “patch,” the annual indexing of the AMT exemption amount for inflation. If the patch is not acted on again this year, the number of individuals owing the AMT will increase from the current 4.4 million to a projected 26.7 million. As of today’s date, the patch has not been enacted for 2010, which means that 22.3 million taxpayers cannot rely on the test of not having paid the tax in the prior year.

5. Use the AMT Planning Model / Dual-tax Calculator at AMTIndividual.com

Fast and easy way to help you determine if you are in the AMT and how much AMT you will owe. It will also show you why you are in the AMT, what items are trapping you, and how to reduce or possibly eliminate the AMT in future years. The Free edition helps individuals better understand the AMT and what items are trapping them for the most recent tax return. The Deluxe edition is a comprehensive version that adds customized, written strategies and the AMT Planner to plan for this current year. Go to www.amtindividual.com to learn more.

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

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 »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 7

Wednesday, December 9th, 2009 | Print This Post | Email This Post

IRS Publication 17 and the Alternative Minimum Tax

Among the many forms and publications the IRS continually updates, including Form 6251, Alternative Minimum Tax – Individuals, each year the IRS reissues its massive Publication 17, entitled Your Federal Income Tax. This is, in essence, a master guide to everything you need to know about individual income taxes. Its length has grown over the years – for 2009, the latest edition just released, it is a book-length 305 pages.

Pub 17 is a useful planning tool because it attempts to explain everything in a simple, summary style. In the midst of our 10-week series of articles focusing in some detail on the individual items that can put a taxpayer into the AMT, it may be an appropriate time to just step back, catch one’s breath, and take a look at the big picture again. Here is how Pub 17 explains the Alternative Minimum Tax:

This section briefly discusses an additional tax you may have to pay.

The tax law gives special treatment to some kinds of income and allows special deductions and credits for some kinds of expenses. Taxpayers who benefit from the law in these ways may have to pay at least a minimum amount of tax through an additional tax. This additional tax is called the alternative minimum tax (AMT).

You may have to pay the alternative minimum tax if your taxable income for regular tax purposes, combined with certain adjustments and tax preference items, is more than:

$70,950 if your filing status is married filing a joint return (or qualifying widow(er) with dependent child),

$46,700 if your filing status is single or head of household, or

$35,475 if your filing status is married filing a separate return.

Adjustments and tax preference items. The more common adjustments and tax preference items include:

Addition of personal exemptions,

Addition of the standard deduction (if claimed),

Addition of itemized deductions claimed for state and local taxes, certain interest, most miscellaneous deductions, and part of medical expenses,

Subtraction of any refund of state and local taxes included in gross income,

Changes to accelerated depreciation of certain property,

Difference between gain or loss on the sale of property reported for regular tax purposes and AMT purposes,

Addition of certain income from incentive stock options,

Change in certain passive activity loss deductions,

Addition of certain depletion that is more then the adjusted basis of the property,

Addition of part of the deduction for certain intangible drilling costs, and

Addition of tax-exempt interest on certain private activity bonds.

More information. For more information about the alternative minimum tax, see the instructions for Form 1040, line 45, and Form 6251, Alternative Minimum Tax – Individuals.

Posted in Calculation of the AMT | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 5

Sunday, November 29th, 2009 | Print This Post | Email This Post

State Income Tax Refunds – AMT Adjustment

The AMT adjustment for State Income Tax Refunds, line 8 on Form 6251, is a reduction to your Alternative Minimum Taxable income. There isn’t much a taxpayer can do about this other than to understand just a little bit of what is going on.

Just for fun, let’s start with the IRS’ explanation for this in the instructions to Form 6251:

“Include any refund from Form 1040 line 10, that is attributable to state or local income taxes. Also include any refunds received in 2009 and included in income on Form 1040, line 21, that are attributable to state or local personal property taxes or general sales taxes, foreign income taxes, or state, local, or foreign real property taxes. Enter the total as a negative amount. If you include an amount from Form 1040, line 21, you must enter a description and the amount next to the entry space for line 8. For example, if you include a refund of real property taxes, enter “real property” and the amount next to the entry space.”

What does this mean in “plain English?” The answer is best done with an example:

Assume a couple paid $5,000 in state income taxes in 2008 and itemized this deduction (Schedule A), which they were allowed to do. But the state income tax return filed showed they had overpaid by $500. This $500 refund was received from the state in April, 2009.

For Regular Tax purposes, the $500 is reported as income in 2009. This is because of the tax principle that if an allowable deduction for some expense is taken in one year (e.g., 2008), but that expense is refunded in the following year, instead of amending the 2008 return to “correct” the deduction, the proper tax fix is to reverse the deduction in 2009 by reporting it as income. Note in total it actually was only a $4,500 expense, which is the deduction of $5,000 less the refund of $500.

For AMT purposes, both income (the refund) and deductions need to be shown on an apples-to-apples basis. Because there is no deduction of the $5,000 state taxes for those in the AMT, any related refund amount, Tax Refunds, line 8, does not require a recovery of that item in income like you see in the Regular Tax. The $500 is deducted from Alternative Minimum Tax income in 2009, effectively netting any impact, income or deduction, to zero.

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

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 5

Wednesday, November 25th, 2009 | Print This Post | Email This Post

Limitation on Itemized Deductions – AMT Adjustment

Depending on a taxpayer’s level of Adjusted Gross Income (“AGI”), the total amount of all the itemized deductions shown on Schedule A of the Form 1040 may not be deductible for Regular Tax purposes – a reduction may apply. For 2009, this AGI level is $166,800 for all taxpayers other than those with the Married Filing Separately status, in which case it is half, or $83,400.

This limitation works in the following manner: from the total of all itemized deductions, one subtracts Medical Expenses, Investment Interest Expense and Casualty Losses – these are not subject to the limitation. From this reduced total an amount that is 1% of the excess of AGI over $166,800 is subtracted. This is the portion of the taxpayer’s itemized deductions for which no Regular Tax benefit is received.

Note that there also is a limitation so that the taxpayer cannot lose more than 2/3 of 80% of the total itemized deductions, but this is rarely encountered.

This wonderfully complicated mechanism is in actuality a hidden tax increase, the apparent brainchild of not-very-well-known former Representative Don Pease of Ohio. This is why it sometimes is referred to as the Pease provision.

Itemized deductions also are disallowed under the AMT, but here a completely different approach is taken. Rather than simply lopping a percentage off the total, the AMT limitations are calculated on an individual deduction-by-deduction basis. For example, state and local taxes are not deductible at all, some interest expense is not deductible, and the medical deduction is subject to a different percentage limitation. With this difference, there is no need for the overall Regular Tax itemized deduction limitation to apply.

As an example, assume a taxpayer has a total of $20,000 in itemized deductions, and that this Regular Tax limitation reduced allowable deductions by $1,000, so that only $19,000 was deductible for the Regular Tax. Since the starting point for calculating the AMT, as shown on Line 1 of IRS Form 6251, is Regular Tax taxable income, this $1,000 adjustment has to be given back. That’s why Line 6 on the Form 6251 is a negative number. After this adjustment is made the individual itemized deduction limitations for the Alternative Minimum Tax are now calculated.

Posted in Calculation of the AMT | 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 »

Indexing

Monday, April 6th, 2009 | Print This Post | Email This Post

The AMT “patch” that Congress passed in the recent stimulus bill saved 24 million taxpayers from falling into the AMT in 2009. As we mentioned in the last article, this temporarily fixed the problem caused by Congress’ original failure to index the AMT for inflation.

What is indexing? Under our system, tax brackets are progressive – i.e., the more you make, the higher your tax bracket. Some time ago Congress decided it wasn’t fair to have you fall into a higher tax bracket if your only increase in income simply reflected inflation. For example, in 2008 a single taxpayer hit the 33% bracket when taxable income reached $164,550. In 2009, that same taxpayer will be able to earn $171,550 before hitting 33% – a 4.3% increase. Presumably the CPI increased by 4.3% during this period. (Economists reading this are welcome to write in and explain how all this actually works).

For the AMT, the level at which an AMT payer goes from the 26% bracket to 28% ($175,000) has not changed. Instead, the Congressional fix is to index the AMT “exemption amount.” For a single taxpayer, in 2008 the exemption amount was $46,200. This is an increase of 4.2% over what it was the previous year, because of Congress’ 2008 patch. If the patch is not enacted, however, the exemption amount reverts all the way back to what it was in 1993 – $33,750 for singles. This is the reason such a large number of you – 24 million – are left hanging out there every year.

Posted in AMT Exemption, Calculation of the AMT, Legislation/tax law changes | 2 Comments »

AMT Exemption Calculation of the AMT Legislation/tax law changes

Tuesday, March 31st, 2009 | Print This Post | Email This Post

Once again we read that Congress has fixed the AMT problem by enacting a temporary “patch” in the recent stimulus bill. With this, 24 million taxpayers who otherwise would be in the AMT in 2009 are spared – but only for one year. Come January 1 these 24 million people again risk falling into the AMT.

What is this all about? It’s simply another example of the law of unintended consequences. When the first minimum tax was enacted back in 1969, it seemed like a good idea – 155 taxpayers making over $200,000 were paying no taxes at all under the regular income tax, so a “minimum” tax would make sure that they did. But today that 155 has exploded to over 4 million who are paying the AMT. Unfortunately, this patch does nothing for you 4 million – it just keeps the other 24 million from joining your exclusive club.

Why is this happening? The principal reason for this kudzu vine-like growth in the number of AMT victims is the failure to index the AMT for inflation, while the Regular Tax is so indexed. The annual patch fixes this with a catch-up AMT indexing adjustment. In our next article we will explain indexing and this annual adjustment.

Why just a one-year patch and not a permanent fix? The answer is simple economics – the revenue loss for the 2009 fix alone is 70 billion dollars. A permanent fix, using Congress’ 10-year forecasting model, could approach a cost of nearly 1 trillion dollars. Now you’re starting to talk about real dollars.

Posted in AMT Exemption, Calculation of the AMT, Legislation/tax law changes | 1 Comment »