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 …There seem to be more and more articles that talk about AMT and now my tax preparer has told me that I am in AMT. How did I get in it and how do I get out?”
This is a typical question that people ask me when they find out that I am a CPA. Although the AMT affects many people today, there are few who really know much about it – and unfortunately, some of those are people who prepare income tax returns.
The AMT or alternative minimum tax was introduced in 1969 because of 155 high-income taxpayers who paid no income tax. Our current AMT structure came into being in 1986. In 2004, approximately 3 million people were subject to AMT, and it is estimated that between 15-30 percent of the population will be subject to the AMT by 2010.
The alternative minimum tax is a parallel tax to the regular income tax. An individual’s taxable income is adjusted by certain items that are deductible for regular tax but not AMT; and for items that are computed differently for AMT purposes. The most common exclusions for AMT are state and local taxes (including real estate taxes), personal exemptions, and miscellaneous itemized deductions. The add back of these deductions alone makes up about 90 percent, in dollar terms, of the total AMT adjustments.
Other common adjustments are depreciation, interest from tax-exempt bonds that invest in certain private activities, the exercise of incentive stock options, and intangible drilling costs and depletion for certain oil and gas investors. One of the most overlooked adjustments for AMT is home mortgage interest that is not used to buy, build, or substantially improve your personal residence. This interest may be fully deductible for regular tax purposes as long as it is secured by your personal residence and meets other limitations, but it is not deductible for AMT.
For married taxpayers who file their returns jointly, the first $62,550 of their income is exempt from AMT ($42,500 for single or head of household and $31,275 for married couples filing separately). The tax rate is 26 percent of income up to $175,000 and then 28 percent on any income above that amount. If filing separately, the 28 percent rate starts at $87,500.
The AMT applies when the alternative minimum tax is greater than the taxpayer’s regular tax liability. Thus, the closer a taxpayer’s effective tax rate is to 28 percent, the higher the likelihood that they will be subject to the AMT.
Tax planning for AMT is very different from typical tax planning. For example, instead of paying a fourth quarter state income tax estimate in December to take the deduction in the current year, for AMT purposes, it may make more sense to defer that deduction to the next year. Likewise, if a taxpayer is in AMT, it may be beneficial to accelerate as much income as they can into that tax year, so that they get a benefit of a lower tax rate – 28 percent versus the top rate of 35 percent. Failing to plan for AMT can be very costly; but timely planning may save tax dollars.
Please contact your Rea team member for more information on the AMT.
-By Robin Y. Retzler, CPA (Shareholder, Tax department / Dublin office)
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