Beware of the AMT
By James J. Cunningham, CPA
It’s tax time and millions of tax payers are in the annual ritual
of reviewing their financial information from the previous year. However,
now is also the time to start thinking of next year’s tax returns
and while there are multiple strategies that taxpayers can use to reduce
their tax liability, they should also beware of an unwelcome visitor
– the Alternative Minimum Tax (AMT).
In 2004 alone, the AMT became something of “a mighty tax,”
ensnaring some 3.5 million individual taxpayers. Next year at tax time,
the AMT will hit approximately 22 million Americans and they will pay
approximately $2,700 more in taxes just because of the AMT. Last year,
it is estimated that 17% of taxpayers earning between $75,000 and $100,000,
39% of those earning between $100,000 and $200,000 and 78% of those
earning between $200,000 and $500,000 were subject to the AMT. As you
can see it affects primarily middle to upper-middle income taxpayers.
By 2011, a higher percentage of taxpayers with incomes between $50,000
and $100,000 will be subject to the AMT than for taxpayers with incomes
exceeding $500,000.
The AMT was created in 1969 to ensure that all taxpayers pay at least
a minimum tax because, under the climate of the time, some high-income
taxpayers were able to significantly reduce or eliminate their regular
tax by taking advantage of tax laws. So, like the best-laid schemes
of mice and men, your tax strategies could go nowhere if your AMT liability
exceeds your regular tax liability. There have been 36 years of inflation
since the AMT’s inception, unfortunately without corresponding
adjustments made to the AMT. That is why so many taxpayers are looking
straight in its face.
The AMT eliminates many deductions or credits that you’ve become
familiar with, leaving you with a considerably higher tax bill. The
AMT becomes due only if it exceeds your regular income tax, as computed
with all of the deductions. Being prepared for the AMT is simply a matter
of knowing your finances and adapting to your circumstances.
The AMT consists of two tax brackets – 26% for incomes below
$175,000 and 28% for incomes above. It allows a standard exemption that
exempts most low-income tax payers - $58,000 for those who are married
filing jointly and $40,250 for most other taxpayers. However, many deductions
allowed in calculating regular tax liability aren’t allowed for
the AMT, such as state and local income taxes, sales taxes, property
taxes and some miscellaneous itemized deductions. Most tax software
tools will help you determine if you are impacted by the AMT or you
can visit http://apps.irs.gov/app/amt/ for an online test.
The following items are includible for AMT purposes. You will need
to reconsider the way you think for regular income tax purposes. The
very things you think of as helpful for computing regular federal income
tax liability proves to be much less so for AMT purposes. This list
is provided for illustrative purposes, and is not meant to be complete:
• The standard deduction
• State and local income taxes
• Personal exemptions
• Income from the exercise of incentive stock options
• Investment expenses
• Home mortgage interest (only home acquisition debt is deductible)
• Net operating loss deductions
• Deductions for medical expenses
• Tax-exempt interest from private activity bonds
• Small business stock gains (that qualify for a 50% tax exclusion)
• Miscellaneous itemized deductions
• Passive income or loss deductions.
Daunting as it might be, it is not impossible to keep a step ahead
of the AMT. At the very least, you can mitigate its effects. Planning,
especially when it concerns AMT mitigation, is a multifaceted task.
Remember that the AMT is a tax computation independent from regular
income tax calculations and, generally speaking, it tends to reduce
the tax benefits of many deductions and credits on your tax return.
For example, medical deductions are only allowed for computing the
AMT if they exceed 10% of your adjusted gross income. This is a tougher
rule than with figuring regular income, which allows for a medical deduction
if medical expenses exceed 7.5% of your adjusted gross income.
Individuals should take full notice of the fact that miscellaneous
itemized deductions are not deductible for AMT purposes as well. This
means that everything from investment expenses, employee business expenses,
work clothes and uniforms, employee home office expenses, to a myriad
of other important deductions are irrelevant for AMT calculations. This
fact alone can have a substantial impact on your overall tax liability,
causing you to lose deductions you previously relied on heavily to reduce
your overall income tax burden.
Finding yourself subject to the AMT requires a different tax perspective
because you must determine how it applies to you. It may not be a tax
you planned to consider, but once it presents itself, approach it as
you would any other challenge. After all, a tax is still a tax.
Be creative, expand your tax knowledge and imagine ways to make it
work for you rather than against you. For instance, if the AMT nullifies
the value of a deduction, shift that deduction to another year, if possible,
and increase your tax savings in that year—assuming you’re
fairly sure you will be AMT-free then.
James J. Cunningham, CPA, is a Tax Shareholder with Alpern Rosenthal,
one of the region’s largest certified public accounting and business
advisory firms. He can be reached at 412.281.2533 or at jcunningham@alpern.com.
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