Capital gains & Dividends

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 7

Sunday, December 13th, 2009 | Print This Post | Email This Post

Investments – Capital Gains

Capital gains are income derived from the sale of property, most typically investment property. While capital gains are not directly an AMT preference item, they do have an impact on a taxpayer’s Alternative Minimum Tax, and, therefore, are an essential element of AMT planning. One real-life scenario with which the writer is familiar involved a retiree with what one would call a typical investment portfolio, including mutual funds, and it was solely a larger-than-usual year-end capital gain distribution from one mutual fund that threw that individual into the AMT.

For a little review, capital gain income historically has been taxed at a rate lower than the rate that applies to other, “ordinary,” income such as salaries and wages and interest income. This lower rate applies only to “long-term” capital gain (LTCG), which means the taxpayer must hold the property for over one year before selling it. Under current law, most dividend income also receives this favorable LTCG treatment.

In general, the tax rates that apply in computing the Alternative Minimum Tax are different from the rates that apply in computing the Regular Tax. However, LTCG is taxed at the same rate for both computations – typically 15%. Thus, a LTCG by itself is not an AMT item. Despite this treatment, however, a LTCG definitely can be a factor that triggers the AMT.

Here’s what happens. First, every taxpayer is entitled to an AMT Exemption amount. This Exemption is designed to prevent taxpayers with only small AMT items from paying the AMT. For example, a couple filing a joint return for 2009 is entitled to an Exemption of $70,950. Unfortunately, however, this Exemption is phased out as the taxpayer’s income increases. The actual phase-out is the loss of $1 of Exemption for every $4 of additional income (i.e., at a 25% rate). So even though LTCG is not a preference item, the more capital gain a taxpayer has the more of his Exemption is phased out and, thus, the more likely he is to pay the AMT. This is exactly what happened to the retiree mentioned above, who, by the way, also happened to be 90 years old at the time. While it may not seem right, there certainly is no AMT forgiveness even for old age!

To illustrate how this works, assume a taxpayer realizes an additional $10,000 of LTCG. In comparing the tax rate schedules for the AMT and the Regular Tax, one would conclude that this capital gain income would have no impact on the taxpayer’s AMT because it is taxed at the same rate under both computations. But here’s what actually happens by adding $10,000 to taxable income:

Income increase
(a) AMT Exemption Phase-out (25%)
(b) Increase in AMT Income (a)+(b)
$10,000 $2,500 $12,500

This increase in AMT income at a rate 25% greater than Regular taxable income is the problem. It is simple math – the more AMT income taxed, the greater the chance of being pulled into the AMT.

In summary, an AMT payer definitely needs to factor capital gains into the equation when doing any tax planning. With year-end now only a little more than two weeks away, anyone thinking of recognizing gains this year had better take this into account.

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