Legislation/tax law changes

Year-End Tax Extenders – Where’s The Patch?

Sunday, December 11th, 2011 | Print This Post | Email This Post

Every year at about this time Congress starts thinking about what tax laws will expire on December 31, and what it really needs to be doing about these. Of the 65 various tax provisions that will expire, one of the big ones is the annual “Patch” for the Alternative Minimum Tax. Without the Patch, nearly 30 million new taxpayers will wake up on New Year’s Day with a lot more than the usual hangover, and the 4 million already in the AMT had better get their checkbooks out for the additional taxes they’ll owe. In addition to this one item, however, there are several other extenders that also can have a direct impact on AMT payers.

What is The Patch and what does it mean to AMT payers?

The Patch is the annual adjustment to the exemption amount allowed in computing each individual’s AMT. Using the married filing jointly example, the exemption for 2011 is $74,450. If the Patch is not enacted for 2012, this amount would drop to $45,000, meaning that the couple’s taxable income subject to the AMT would increase by $29,450 – the difference between these two numbers. This could mean an additional $8,000 in Alternative Minimum Tax due in 2012!

Personal tax credits allowed against the AMT

The tax law is replete with what are known as “tax credits.” A tax credit is distinguished from a tax deduction in that it is a direct reduction of your tax liability instead of a reduction of your taxable income in computing your tax liability. For example, if you are in the 26% AMT bracket a $100 tax deduction would save you $26 in taxes. Compare this with a $100 tax credit, which would reduce your taxes by the full $100. One example of a credit that a taxpayer might be eligible is that allowed for making certain energy-efficient improvements to one’s personal residence.

A significant number of tax credits are allowed only to individuals paying the Regular Tax, denying those stuck in the AMT a similar benefit. On occasion, however, Congress has seen fit to extend these benefits to AMT payers, but only for one year at a time. A number of these types of credits are on the tax extenders list.

State and local sales tax deduction

For individuals living in a state with no personal income tax, Congress has on occasion allowed these folks a deduction for state and local sales tax paid. This deduction currently is on the list of extenders that are needed in 2012. Just like other state and local taxes – property taxes and income taxes, for example – a deduction for state sales tax is allowed for Regular Tax purposes but not for Alternative Minimum Tax payers. Thus, for individuals in these states the extension – or not – of this as an allowable deduction can have a direct impact on their AMT paid.

Small business stock

Gains from the sale of qualifying “small business stock” may not need to be fully reported for purposes of the Regular Tax. For the AMT, however, a portion of the gain needs to be added back into taxable income. Some of the special rules that apply to small business stock are on one-year extenders, so an AMT payer with this item will be affected by these extenders.

Percentage depletion

For investors and operators in the oil and gas business, the use of percentage depletion can trigger the AMT. Percentage depletion computations are complex, with several limitations imposed in the various steps of the calculations. The extension of one of these items, knows as the 100%-of-net-income limitation, could have a direct impact on affected AMT payers.

Conclusion

Politics being politics, one never knows with any certainty what Congress is going to do or when they are going to do it. Historically, however, these extenders – including The Patch – have been enacted, although more often than not well past the deadline but on a retroactive basis. Readers are advised to keep an eye on developments on this important topic.

Posted in AMT credits, AMT Exemption, AMT Items, Credits Allowable, Legislation/tax law changes, State Income & Other Taxes, The "patch" | No Comments »

IRS Announces 2012 Inflation Adjustments, Once Again Highlighting the Need for Another Alternative Minimum Tax “Patch”

Friday, October 21st, 2011 | Print This Post | Email This Post

As it does in the fall of every year, the IRS has calculated the effect that inflation has had on the income tax brackets that are used to compute the individual income tax, and it recently has announced what the tax brackets will be for 2012. These adjustments are required under the tax law, but they are limited to the Regular Tax brackets only – no similar adjustments are made for the Alternative Minimum Tax. Unless Congress specifically addresses the issue with another AMT Patch, this mismatch will result in approximately 25 million additional taxpayers becoming subject to the AMT in 2012.

The Patch

The Patch, as it is famously known, is the mechanism used by Congress to offset the failure of the tax law to automatically require an adjustment of the AMT brackets for inflation. This failure, with the resulting need for the annual Patch, has been going on since 2000, over a decade now. The reason for the constant one-year fixes, or “patches,” is simple – it has been estimated that a permanent fix would cost in excess of one trillion dollars. While the one-year fixes in and of themselves are expensive, there is simply no way that Congress could ever find enough money to do a permanent fix in the absence of a complete overhaul of our U.S. tax system.

The AMT exemption

The actual Patch mechanism is the making of an adjustment to the Alternative Minimum Tax exemption amount. For a married couple filing a joint return, for 2011 the exemption amount is $74,450 (other filing statuses have different exemption amounts). What this means is that taxable income for AMT purposes will be $74,450 less than what it otherwise would be, after increasing Regular Tax taxable income for the numerous AMT adjustment items. The purpose of this is to ensure that folks at lower levels of taxable income, and folks who don’t have very many AMT items, are not caught in the AMT net.

What happens if there is no Patch

If Congress does not enact another Patch, the exemption amount will drop significantly, all the way back to what it was in 2000. For a married couple, this would equate to an exemption of only $45,000 – 40 percent less than what it is today. This substantial drop in the exemption would result in the 25 million additional AMT payers mentioned above.

When will Congress act?

Although one can never predict when Congress will get around to doing things, as we have seen time and time again Congress does tend to postpone dealing with difficult issues until the very last moment. Thus, even though these 25 million individuals technically become AMT payers on January 1, 2012, the average time it has taken Congress to enact the Patch is seven months into the tax year. Thus, if they followed this average we won’t know until July, 2012 what the revised exemption amount is. But don’t’ assume July – twice during the past decade it has actually taken Congress until December to enact the Patch.

The “Patch watch”

Congress knows what it needs to do. All that can be done is to wait, and watch and monitor the goings-on in Washington. Future articles will be doing exactly this, and reporting on any developments when they occur.

Posted in AMT Exemption, Calculation of the AMT, Legislation/tax law changes, The "patch" | No Comments »

Index the Individual Alternative Minimum Tax Amounts for Inflation

Monday, July 4th, 2011 | Print This Post | Email This Post

More from the Joint Committee on Taxation – just-released report “Description of Revenue Provisions Contained in the President’s Fiscal Year 2012 Budget Proposal.” This massive 647-page report contains a proposal for a permanent Alternative Minimum Tax “patch,” as set forth below.

Present Law

Present law imposes an alternative minimum tax (“AMT”) on individuals. The AMT is

the amount by which the tentative minimum tax exceeds the regular income tax. An individual’s tentative minimum tax is the sum of (1) 26 percent of the first $175,000 ($87,500 in the case of a married individual filing a separate return) of the excess of alternative minimum taxable income (“AMTI”) over the AMT exemption amount and (2) 28 percent of the remaining excess. The maximum tax rates on net capital gain and dividends used in computing the regular tax are used in computing the tentative minimum tax. AMTI is the individual’s taxable income adjusted to take account of specified preferences and adjustments.

The exemption amounts are: (1) $74,450 ($45,000 in taxable years beginning after 2011)

in the case of married individuals filing a joint return and surviving spouses; (2) $48,450

($33,750 in taxable years beginning after 2011) in the case of other unmarried individuals; (3) $37,225 ($22,500 in taxable years beginning after 2011) 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.

Present law provides for certain nonrefundable personal tax credits. These credit include

the dependent care credit, the credit for the elderly and disabled, the adoption credit, the child credit, the credit for interest on certain home mortgages, the Hope Scholarship and Lifetime Learning credits, the credit for savers, the credit for certain nonbusiness energy property, the credit for residential energy efficient property, the credit for certain plug-in electric vehicles, the credit for alternative motor vehicles, the credit for new qualified plug-in electric drive motor vehicles, and the D.C. first-time homebuyer credit.

For taxable years beginning before 2012, the nonrefundable personal credits are allowed

to the extent of the full amount of the individual’s regular tax and alternative minimum tax. For taxable years beginning after 2011, the nonrefundable personal credits (other than the adoption credit, the child credit, the Hope Scholarship credit (for taxable years beginning after 2012), the credit for savers, the credit for residential energy efficient property, the credit for certain plug-in electric vehicles, the credit for alternative motor vehicles, and the credit for new qualified plug-in electric drive motor vehicles) are allowed only to the extent that the individual’s regular income tax liability exceeds the individual’s tentative minimum tax, determined without regard to the minimum tax foreign tax credit. The adoption credit, the child credit, the Hope Scholarship credit (for taxable years beginning before 2013), the credit for savers, the credit for residential energy efficient property, the credit certain plug-in electric vehicles, the credit for alternative motor vehicles, and the credit for new qualified plug-in electric drive motor vehicles are allowed to the full extent of the individual’s regular tax and alternative minimum tax.1640

Description of Proposal

The proposal provides that the individual AMT exemption amounts, including the

thresholds for the phaseout of the exemption amounts, are indexed for inflation from the levels in effect for 2011. The proposal indexes the threshold amounts for the beginning of the 28-percent bracket. The proposal allows an individual to offset the entire regular tax liability and alternative minimum tax liability by the nonrefundable personal credits.

Effective date.–The proposal is effective for taxable years beginning after 2011.

Analysis

Allowing the nonrefundable personal credits to offset the regular tax and alternative

minimum tax, and increasing the exemption amounts, will substantially reduce the number of taxpayers affected by the AMT. In addition to the reduction in tax liability as a result of this change, there will be significant simplification benefits. Substantially fewer taxpayers will need to complete the alternative minimum tax form (Form 6251), and the forms and worksheets relating to the various credits can be simplified.

By permanently establishing the AMT exemption levels and ability to take nonrefundable

credits against the AMT, the proposal provides greater certainty for taxpayers as to their tax obligation resulting from the AMT, in comparison to the practice over the past years of annually adjusting the exemption levels to prevent their reversion to the levels in effect prior to EGTRRA. Additionally, by indexing the AMT system for inflation, as is done in the regular tax system, the proposal prevents tax increases in real terms for the portion of one’s income growth that merely accounts for inflationary growth. By doing so, the proposal substantially slows the rate of growth in the number of taxpayers subject to the AMT over time.

A number of analysts argue that the proposal does not go far enough, advocating instead

the abolition of the AMT. Their argument rests on the observation that the AMT system has outlived its original purpose of requiring taxpayers engaged in substantial sheltering of income to pay at least some minimum tax. Instead, taxpayers today are mainly ensnared by the AMT as a result of their income level, payment of state and local taxes, and presence of dependents. Such analysts argue that requiring such taxpayers to calculate their liability two ways is needlessly complex and serves no discernible policy objective that the regular tax alone couldn’t provide.

1640 The rule applicable to the child credit after 2012 is subject to the EGTRRA sunset. The adoption credit

is refundable in 2011 and beginning in 2012 is nonrefundable and treated in the same manner as the child credit.

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Joint Committee on Taxation Hearing on Fundamental Tax Reform

Saturday, June 18th, 2011 | Print This Post | Email This Post

The Joint Committee on Taxation recently held a public hearing which it called a Roundtable Discussion on Ideas for Reforming the U.S. Internal Revenue Code. Much of the testimony addressed the need to reform the Alternative Minimum Tax. The quote below is just one example of many such comments made.

“Tax reform may also be more difficult due to the temporary nature of several key provisions in the tax code that significantly raise current official projections of future revenues, and greatly complicate any proposal for fundamental tax reform if it is required to replace all of these revenues (as was made clear in the report of the 2005 Tax Panel). Most important is the alternative minimum tax (AMT) which, despite annual congressional “patches” that limit its reach, is assumed in future years to raise significant revenues from a large fraction of middle income taxpayers. Similarly, official projections assume that all of the Bush tax cuts are allowed to expire, which also results in significantly larger future revenues.

“We believe that fundamental reform of the income tax structure is sufficiently difficult that the process of reform should not be encumbered by a requirement to raise additional revenues, which would ensure that many, if not most, taxpayers would end up being “losers” from reform, making the passage of reform virtually impossible from a political perspective. Although we understand that additional revenues will be needed in the future to address our nation’s deficit and debt problems as well as to eliminate the AMT, we believe that raising rates within a reformed tax structure to obtain additional revenues, in conjunction with spending cuts as part of a sweeping fiscal reform package, must be treated as a separate issue if fundamental tax reform is to be politically feasible. Moreover, we believe that such treatment should be extended to the AMT and the Bush tax cuts; that is, we propose that the revenue (and distributional) baselines for fundamental tax reform assume that the AMT patches and the Bush tax cuts will be permanently extended. Thus, we propose a two-stage approach to reform—a revenue-neutral fundamental tax reform under the assumptions outlined above, followed by fiscal reform that reduces future budget deficits while reaching a compromise on distributional issues.

“We propose an individual tax reform that would substantially reduce or eliminate many tax credits, deductions, and exemptions while consolidating and simplifying other tax preferences—that is, a base-broadening, rate-reducing (BBRR) reform similar to TRA86. TRA86 broadened the tax base by eliminating the exclusion for long-term capital gains, the investment tax credit, the deduction for two-earner families, income averaging, the deduction for state and local sales taxes, and the deduction for interest on consumer loans, including credit card interest. It also limited deductions for depreciation, passive activity losses, business meals and entertainment, medical expenses, and expanded the AMT to include deductions utilized by most households. Much of the resulting revenues were used to reduce rates, although standard deductions and personal exemptions were also increased significantly. However, TRA86 did not limit or eliminate the home mortgage interest deduction, the deduction for employer-provided health insurance, the deductions for state and local income and property taxes, the deduction for charitable contributions, or the exemption of interest on public purpose state and local bonds.”

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Joint Committee on Taxation – Tax Expenditures and the Alternative Minimum Tax

Saturday, March 12th, 2011 | Print This Post | Email This Post

The Joint Committee on Taxation recently issued a report on tax expenditures. “Tax expenditures” are government spending that is accomplished through the Internal Revenue Code – in effect a negative tax. The tax expenditure term was created over 40 years ago by Stanley Surrey, then Assistant Secretary of the Treasury, as a way to describe the political use of tax breaks for means that were more typically accomplished through direct government spending.

Set forth below is an excerpt from this recent report – the part addressing the Alternative Minimum Tax. It makes for interesting reading, especially when one finds such comments as “the AMT is not viewed as part of normal income tax law.”

The report:

Under the Joint Committee staff view of normal tax law, compensatory stock options would be subject to regular income tax at the time the options are exercised and employers would receive a corresponding tax deduction. If the option has a readily ascertainable fair market value, normal law would tax the option at the time it is granted and the employer would be entitled to a deduction at that time. The employee’s income would be equal to the difference between the purchase price of the stock and the market price on the day the option is exercised.

Present law provides for special tax treatment for incentive stock options and options acquired under employee stock purchase plans. When certain requirements are satisfied, then: (1) the income that is received at the time the option is exercised is excluded for purposes of the regular income tax but, in the case of an incentive stock option, included for purposes of the alternative minimum tax (“AMT”); (2) the gain from any subsequent sale of the stock is taxed as a capital gain; and (3) the employer does not receive a tax deduction with respect to the option. The special tax treatment provided to the employee is viewed as a tax expenditure by the Joint Committee staff. However, it should be noted that the revenue loss from the special tax treatment provided to the employee is accompanied by a significant revenue gain from the denial of the deduction to the employer. The negative tax expenditure created by the denial of the deduction for employers is incorporated in the calculation of the tax expenditure.

The individual AMT and the passive activity loss rules are not viewed by the Joint Committee staff as a part of normal income tax law. Instead, they are viewed as provisions that reduce the magnitude of the tax expenditures to which they apply. For example, the AMT reduces the value of the deduction for State and local income taxes (for those taxpayers subject to the AMT) by not allowing the deductions to be claimed in the calculation of AMT liability. Similarly, the passive loss rules defer otherwise allowable deductions and credits from passive activities until a time when the taxpayer has passive income or disposes of the assets associated with the passive activity. Exceptions to the individual AMT and the passive loss rules are not classified as tax expenditures by the Joint Committee staff because the effects of the exceptions already are incorporated in the estimates of related tax expenditures. In one case the restrictive effects of the AMT are presented separately because there are no underlying positive taxexpenditures reflecting these effects: the negative tax expenditures for the AMT’s disallowance of personal exemptions and the standard deduction.

Posted in Incentive Stock Options Exercised, Legislation/tax law changes, Personal Exemptions, Standard Deduction, State Income & Other Taxes | No Comments »

Joint Committee on Taxation Explains the Recently-Passed AMT Patch

Thursday, February 3rd, 2011 | Print This Post | Email This Post

One of the functions of the staff of the Joint Committee on Taxation is to prepare non-technical explanations of tax law changes, both for Members of Congress as they deliberate on a bill as well as for tax advisers and others who want a better understanding of tax law changes. Set forth below is the official staff explanation of the recently-enacted AMT patch.

TECHNICAL EXPLANATION OF THE REVENUE PROVISIONS CONTAINED IN THE “TAX RELIEF, UNEMPLOYMENT INSURANCE REAUTHORIZATION, AND JOB CREATION ACT OF 2010”

TITLE II − TEMPORARY EXTENSION OF INDIVIDUAL ALTERNATIVE MINIMUM TAX RELIEF

Extension of Alternative Minimum Tax Relief for Nonrefundable Personal Credits and Increased Alternative Minimum Tax Exemption Amount (secs. 201 and 202 of the bill and secs. 26 and 55 of the Code)

Present Law

Present law imposes an alternative minimum tax (“AMT”) on individuals. The AMT is

the amount by which the tentative minimum tax exceeds the regular income tax. An individual’s 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 used in computing the tentative minimum tax. AMTI is the individual’s taxable income adjusted to take account of specified preferences and adjustments.

The exemption amounts are: (1) $70,950 for taxable years beginning in 2009 and $45,000 in taxable years beginning after 2009 in the case of married individuals filing a joint return and surviving spouses; (2) $46,700 for taxable years beginning in 2009 and $33,750 in taxable years beginning after 2009 in the case of other unmarried individuals; (3) $35,475 for taxable years beginning in 2009 and $22,500 in taxable years beginning after 2009 in the case of married individuals filing separate returns; and (4) $22,500 in the case of an estate or trust. The exemption amount is 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.

Present law provides for certain nonrefundable personal tax credits (i.e., the dependent care credit, the credit for the elderly and disabled, the child credit, the credit for interest on certain home mortgages, the Hope Scholarship and Lifetime Learning credits, the credit for savers, the credit for certain nonbusiness energy property, the credit for residential energy efficient property, the credit for certain plug-in electric vehicles, the credit for alternative motor vehicles, the credit for new qualified plug-in electric drive motor vehicles, and the D.C. first-time homebuyer credit).

For taxable years beginning before 2010, the nonrefundable personal credits are allowed

to the extent of the full amount of the individual’s regular tax and alternative minimum tax.

For taxable years beginning after 2009, the nonrefundable personal credits (other than the

child credit, the credit for savers, the credit for residential energy efficient property, the credit for certain plug-in electric drive motor vehicles, the credit for alternative motor vehicles, and credit for new qualified plug-in electric drive motor vehicles) are allowed only to the extent that the individual’s regular income tax liability exceeds the individual’s tentative minimum tax, 38 determined without regard to the minimum tax foreign tax credit. The remaining nonrefundable personal credits are allowed to the full extent of the individual’s regular tax and alternative minimum tax.30

Explanation of Provisions

The provision allows an individual to offset the entire regular tax liability and alternative

minimum tax liability by the nonrefundable personal credits for 2010 and 2011. The provision provides that the individual AMT exemption amount for taxable years beginning in 2010 is (1) $72,450, in the case of married individuals filing a joint return and surviving spouses; (2) $47,450 in the case of other unmarried individuals; and (3) $36,225 in the case of married individuals filing separate returns. The provision provides that the individual AMT exemption amount for taxable years beginning in 2011 is (1) $74,450, in the case of married individuals filing a joint return and surviving spouses; (2) $48,450 in the case of other unmarried individuals; and (3) $37,225 in the case of married individuals filing separate returns.

Effective Date

The provision is effective for taxable years beginning after 2009.

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

Legislative History of the AMT as Summarized by the Joint Committee on Taxation

Wednesday, January 26th, 2011 | Print This Post | Email This Post

As a part of its preparation for the House Ways and Means Committee hearings on fundamental tax reform, the Joint Committee on Taxation prepared a summary history of the Alternative Minimum Tax. Here is the Joint Committee’s report:

An add-on minimum tax was first enacted by the Tax Reform Act of 1969. The add-on minimum tax was repealed by The Tax Equity and Fiscal Responsibility Act of 1982. The add-on minimum tax, as originally enacted, generally was a tax at a 10-percent rate on the sum of the specified tax preferences in excess of the sum of $30,000 plus the taxpayer’s regular tax.

The 1982 Act enacted the first comprehensive individual AMT. Under the 1982 Act, in computing AMTI, the deduction for state and local taxes, the deduction for personal exemptions, the standard deduction, and the deduction for interest on home equity loans were not allowed. Incentive stock option gain was included in AMTI. These remain the principal preferences and adjustments under present law. The Tax Reform Act of 1986 largely retained the structure of the prior-law AMT, since 1986, several changes have been made to the computation of the individual AMT. The principal changes are set forth below:

Adjustments and preferences – The principal changes made in the determination of AMTI were to repeal the preference for charitable contributions of appreciated property; repeal the preference for percentage depletion on oil and gas wells; substantially reduce the amount of the preference for intangible drilling expenses; and repeal the requirement that alternative depreciation lives be used in computing the deduction for ACRS depreciation.

Rates – The Omnibus Budget Reconciliation Act of 1990 increased the individual AMT tax rate from 21 percent to 24 and the rate was further increased by the Omnibus Budget

Reconciliation Act of 1993 to the 26- and 28-percent rate structure of present law (when the maximum regular tax rate was increased from 31 percent to 39.6 percent).

Exemption amounts – The Omnibus Budget Reconciliation Act of 1993 increased the

AMT exemption amounts to $45,000 ($33,750 for unmarried taxpayers). The AMT exemption amounts were temporarily increased to $49,000 ($35,750 for unmarried individuals) for 2001 and 2002, to $58,000 ($40,250 for unmarried individuals) for 2003, 2004, and 2005, to $62,550 ($42,500 for unmarried individuals) for 2006, $66,250 ($44,350 for unmarried individuals) in 2007, $69,950 ($46,200 for unmarried individuals) in 2008, to $70,950 ($46,700 for unmarried individuals) in 2009, and $72,450 (($47,450 for unmarried individuals) for 2010, and $74,450 ($48,450 for unmarried individuals) in 2011.

Credits – For 1998 and subsequent years, the nonrefundable personal credits have been allowed on a temporary basis to offset the AMT. The last extension, through 2011, was enacted by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

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

Posted in AMT credits, AMT Exemption, Calculation of the AMT, History of the AMT, Legislation/tax law changes | No Comments »

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 »

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 »