The “patch”

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

Sunday, December 11th, 2011 | Print This Post Print This Post | Email 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 Print This Post | Email 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 Print This Post | Email 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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Who Has to File the Form 6251?

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