Alternative minimum tax (AMT) is no longer affecting just high-income individuals. It is spreading to many middle-income Americans. It has been projected that for 2012 about 31 million Americans will be paying AMT.
There are no specific tests to determine if you are liable for AMT. You must first figure your regular income tax, and then determine whether tax benefit items must be added back to your taxable income to calculate AMT. Without these items added back, some taxpayers might be able to escape income tax entirely. The IRS cannot let that happen! In essence, the alternative minimum tax is a recapture mechanism, reclaiming tax breaks allowed by the IRS itself.
You may owe AMT if you claimed:
- Itemized deductions such as taxes, interest, medical expenses and miscellaneous deductions;
- Certain tax-exempt interest, incentive stock option benefits or accelerated depreciation, and/or
- A substantial number of dependents (exemptions).
The deduction items that are added back are classified as either “preference” items or “adjustment” items, each having a significant tax impact. Preference items are deductions that are allowed in computing regular taxable income, but are not allowed in computing alternative minimum taxable income. Deductions that are preference items are eliminated or reduced each year to reflect the amounts that are considered preferential. These items can only increase alternative minimum taxable income, not decrease it. Preference items can include tax-exempt interest on qualified private activity bonds, accelerated depreciation on property acquired before 1987, or qualifying small-business stock.
Adjustment items are items of income and deductions that are computed differently for AMT than for regular tax. Adjustments can increase or decrease AMT income. Adjustments can include mortgage interest, state and local taxes, MACRS depreciation, incentive stock options, long-term contracts, research and experimental expenses, and other items. These adjustments are usually required to eliminate a timing difference that can result from tax laws allowing the acceleration of deductions (e.g., MACRS depreciation) or the deferral of income. Thus, the recalculation usually results in an increase to AMT income.
Every year taxpayers need to consider whether they will have to pay the AMT. The AMT Assistant is intended to provide a simple test for taxpayers who complete their tax returns without using software to determine whether they may be subject to AMT. You can access the AMT Assistant online at http://www.irs.gov/businesses/small/article/0,,id=150703,00.html. The AMT Assistant is an electronic version of the “Worksheet to See if You Should Fill in Form 6251 – Line 45” found in the 1040 Instructions (http://www.irs.gov/pub/irs-pdf/i1040gi.pdf). You answer a few simple questions about entries on your draft 1040, and the system does the rest. You will see the results immediately on your computer screen. Based on your entries, the results tell you either you do not owe the AMT or that you must go further and complete Form 6251, Alternative Minimum Tax – Individuals, to determine if you owe the AMT. Your entries are anonymous and the information will be used only for purposes of determining your eligibility. All entries are erased when you exit or start over. The online assistant can be used by individuals, tax practitioners and community or public service organizations.
A taxpayer’s regular income tax is compared to the tentative minimum tax. The net minimum tax due is the amount by which the tax computed exceeds the taxpayer’s regular tax. In a sense, it is a true alternative tax. Technically, the taxpayer’s regular tax continues to be imposed and the net minimum tax is additional.
Before you tackle your Form 6251, let me give you some points of interest:
- If you claimed the standard deduction rather than itemizing on your return, you may not claim the standard deduction as an AMT deduction. Standard deductions are disallowed. This is an adjustment item.
- Exemptions for yourself and your dependents are not allowed for AMT purposes. Inflation-indexing of personal exemption amounts has triggered taxpayers with large families into AMT situations. The Tenth Circuit appeals court and the Tax Court (although “sympathetic”) agree that the AMT rules apply. If you are subject to AMT tax because you have a large family, then you must pay the AMT tax. After all, rules are rules.
- If you exercise incentive stock options, you have to treat the difference between your purchase price and the fair market value at the time of purchase as an AMT adjustment. This income benefit is added to your alternative minimum income. The only way to avoid this adjustment item is to sell the stock in the same year in which you exercise the option. Reminder: Your AMT basis in your stock acquired through the exercise of an ISO is increased by the amount of the required AMT adjustment. Therefore, you must keep basis records for both AMT and regular income tax purposes, since in the year the stock is sold, the reportable gain for AMT purposes should reflect the basis adjustment. This is an adjustment item.
AMT is reported and paid with your regular income tax. It is subject to the same filing requirements, payment of estimated taxes and record keeping requirements.
When a taxpayer pays alternative minimum tax, the amount of the tax paid is allowed as a credit against the regular tax liability of the taxpayer in subsequent years. However, the credit (called the minimum tax credit) cannot be used to reduce the tentative minimum tax in subsequent years. The minimum tax credit applies only to the AMT created as a result of deferred preference items.
AMT, potentially, affects every income tax planning strategy. Taxpayers must focus not only on their income tax strategy, but now reducing the impact of their AMT. If you would like any additional information regarding this issue or any other tax related issue, please contact Henssler Financial at 770-429-9166 or at experts@henssler.com
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
