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The Alternative Minimum Tax (AMT) is a tax that was originally intended to ensure that wealthier taxpayers with large write-offs and tax-sheltered investments pay at least a minimum tax. To accomplish this, Congress created a second (alternative) tax computation that adds back to income certain tax preferences and eliminates some deductions. Taxpayers then compute their tax both ways and pay the higher of the two taxes. When it originated back in the ‘70s, the AMT impacted just a few, very wealthy, individuals. However, unlike the regular tax computation, the AMT has not been fully adjusted for inflation and years of inflation have driven everyone’s income up to where the number of taxpayers being affected by the AMT increased.
However, tax reform passed by Congress in 2017, and effective in 2018, increased the amount of income that’s exempt from the AMT, including significantly upping the threshold at which the exemption phases out. Along with other tax reform changes that effectively remove some of the deductions previously targeted by the AMT, fewer individuals will be subject to the AMT, at least through 2025 when many of the changes will revert to prior law unless Congress extends the tax reform provisions.
Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. Although it is not always possible to avoid the AMT, it is sometimes possible to minimize this punitive tax by taking certain steps. Therefore, it is important for a taxpayer to have a basic understanding of the circumstances that can create an AMT.
The AMT includes a myriad of adjustments and preference items and full or partial disallowances of certain deductions that are otherwise perfectly legal and allowed in figuring the regular income tax. There are far too many to discuss, especially those that are rarely encountered by the average taxpayer. There are, however, certain AMT issues that frequently affect taxpayers. They are listed below with comparisons to the regular tax computation, along with actions that might be taken to mitigate the effects of the AMT.
Personal Exemptions
For years 2018-2025 the personal exemption deduction is suspended for federal purposes and does not factor into the federal AMT computation.
For years other than 2018-2025, every taxpayer, spouse and dependent included on a taxpayer’s tax return generates an exemption deduction for regular tax purposes. For AMT purposes, the personal exemption deduction is not allowed at all. When two individuals can possibly claim the exemption, such as in the case of a multiple support agreement between children supporting elderly parents, care should be taken to ensure the exemption is not claimed by one who is subject to the AMT.
Standard Deduction
For regular tax purposes, a taxpayer can choose between using the standard deduction or itemizing deductions. For AMT purposes, this creates sort of a dilemma for those who don’t have enough deductible expenses to itemize for regular tax purposes but do have substantial itemized deductions that can be used to offset the AMT. However, taxpayers can elect to itemize even if the deductions are less than the standard deduction.
Itemized Deductions
The itemized deductions allowed for the AMT are far more restrictive than those allowed for regular tax purposes. The following is a comparison of the two:
* Certain Private Activity Bonds issued in 2009 and 2010 are not subject to AMT tax.
Statutory Stock Options (Incentive Stock Options) Also Referred to AS ISOS
When this type of option is exercised, there is no income for regular tax purposes. However, the bargain element (difference between grant price and exercise price) produces preference income for AMT purposes in the year the option is exercised. The tax benefit of ISOs for regular tax purposes results when the stock acquired by exercising the option has been held the requisite time before it is sold, allowing gains to be taxed at the more favorable long-term capital gains rates. However, if one is being taxed by the AMT, the bargain element is taxable in the year of exercise which generally mitigates the regular tax benefits. If possible and when the investment considerations allow it, exercising ISOs in small blocks of stock may allow a taxpayer to avoid the AMT and take advantage of the long-term capital gains benefit. Otherwise, it may be better strategy to avoid the AMT preference issues altogether by selling the stock in the year of exercise. This is a complex area of tax law; please call this office for further details.
Depletion Allowance
For both regular tax and AMT purposes, the tax law allows taxpayers to deduct an allowance for depleting (using up) an asset such as interest in an oil well. However, once the total depletion on the asset exceeds a taxpayer’s investment in the property (basis), the depletion allowance is only allowed for regular tax purposes and not for AMT, thus creating AMT preference income.
Excess Depreciation
Generally, for regular tax purposes, equipment that a taxpayer acquires for use in business is depreciated (deducted over several years) using the 200% declining balance method. For AMT tax purposes, the equipment cannot be depreciated faster than the 150% declining balance method. The difference between these two methods of depreciation creates the AMT preference income. If a taxpayer is habitually taxed by the AMT method, it might be appropriate to always use the 150%declining balance method and thereby avoid the preference income. In addition, the Sec 179 expense deduction is allowable in full for both the regular tax and the AMT. It might be appropriate to utilize the Sec 179 deduction rather than depreciating the asset at all if other considerations will allow it.
Other AMT Adjustments
There are several additional AMT issues, including adjustments in the gain or loss from the sale of assets due to differences in regular tax and AMT basis created by different depreciation rates and preference income, intangible drilling costs, sale of small business stock, passive losses, passive farm losses, research and experimental expenditures, circulation costs and mining development and exploration costs, that are rarely encountered by individual taxpayers and are not discussed in this brochure. Please call this office for further details if such issues are encountered.
Computing the AMT
In computing the Alternative Minimum Tax, a substantial exemption amount is allowed against the AMT taxable amount based upon filing status. The exemption amount phases out as the taxpayer’s AMT taxable income increases. Illustrated are the exemption amounts for 2019. These amounts are subject to annual inflation adjustments. Please call this office for amounts applicable to any other year.
AMT EXEMPTION & PHASE OUT
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Filing Status | Exemption Amount | Income Where Exemption is Totally Phased Out |
Married Filing Jointly | $111,700 | $1,467,400 |
Married Filing Separate | $55,850 | $733,700 |
Unmarried | $71,700 | $797,100 |
The advice included in this article is not intended or written by this practitioner to be used, and it cannot be used by a practitioner or taxpayer, for the purpose of avoiding penalties that may be imposed on the practitioner or taxpayer.
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