July 3, 2012
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On December 22, 2017, The Tax Cuts and Jobs Act was signed into law. The information in this article predates the tax reform legislation and may not apply to tax returns starting in the 2018 tax year. You may wish to speak to your tax advisor about the latest tax law. This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
AMT is the acronym for
Alternative Minimum Tax
. It is a different (alternative), and generally punitive, method of computing income tax when either certain types of income receive preferential tax treatment or there are excessive deductions in certain categories. Congress originally implemented it to impose a minimum tax on higher-income taxpayers who were avoiding taxes through tax shelters and other legal means. However, years of inflation without corresponding adjustment to the AMT components have, each successive year, caused an increasing number of taxpayers to be subject to the AMT.
Just as the regular income tax allows personal exemptions, the AMT calculation allows an exemption, but it is based upon filing status. For the past several years, Congress has, on a year-to-year basis, increased that exemption for inflation. However, should they fail to provide an increase for 2012, the exemption amounts would revert to levels not seen since the early 2000s, which, depending upon filing status, would result in an approximate 30% to 40% decrease in the exemption amount. For example, the exemption amount for joint filers would drop from 2011's $74,450 to $45,000. The reduction of the exemption amount would snare a significantly greater number of taxpayers for 2012—estimated to be around 31 million, versus 4 million for 2011.
Other factors that can create an AMT for the average taxpayer include the following:
Medical Deductions – Medical deductions are allowed for the AMT computation, but only to the extent that they exceed 10% of a taxpayer's income. In contrast, the regular tax computation limit is a lesser 7.5%. (Starting in 2013, as part of the Health Care Act changes, the 7.5% will increase to 10% for regular tax also for taxpayers under age 65.) When a taxpayer knows that he is going to be affected by the AMT, it is sometimes possible to defer or accelerate medical expenses from one year to another, such as paying the orthodontist in installments or all at once. If your employer offers one, consider participating in a health flexible spending plan (FSA). It allows you to pay medical expenses with pre-tax dollars and avoid both the regular tax and AMT deduction limitations. However, starting in 2013, the maximum amount available for reimbursement of incurred medical expenses under the health FSA for a plan year (or other 12-month coverage period) cannot exceed $2,500 (adjusted for inflation beginning in 2014).
Tax Deductions – When itemizing deductions, a taxpayer is allowed to deduct a variety of taxes , including real property, personal property, and state income tax. But for AMT purposes, none of the itemized taxes are deductible. For most taxpayers, this represents one of their largest tax deductions and frequently triggers the AMT. If you are affected by the AMT, conventional wisdom would dictate deferring tax payments to a subsequent year when the AMT may not apply. When deferring, care should be exercised in regards to late payment penalties and interest on underpayments for certain taxes. In addition, taxpayers can annually elect to capitalize taxes on unimproved and unproductive real estate. This means foregoing the deduction currently and adding the tax paid to the cost basis of the real property.
Home Mortgage Interest – For both the regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a home or second home is deductible as long as the debt limit (generally $1.1 million) is not exceeded. This is true of refinanced debt, except that any increase in debt is treated as equity debt. For regular tax purposes, the interest on up to $100,000 of equity debt on the two homes can be deducted. However, equity debt is not deductible against the AMT, and neither is the acquisition or equity debt interest on a motor home or boat that qualifies as a second home. Therefore, taxpayers should exercise caution when incurring home equity debt. Generally, loan brokers are not aware of these limitations, and there are numerous pitfalls.
Miscellaneous Itemized Deductions – The category of miscellaneous deductions that includes employee business expenses and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this can create a significant AMT. Employees with significant employee business expenses should attempt to negotiate an "accountable" reimbursement plan with their employer. Under this type of plan, the reimbursement for qualified expenses is tax-free. Because the employee has been reimbursed, he or she no longer claims a deduction for the expenses, thus eliminating the miscellaneous deduction. Another strategy would be to defer the expenses to a year not affected by the AMT.
Personal Exemptions – Personal exemptions for dependents provide no benefit when taxed by the AMT method. Therefore, divorced or separated parents should carefully consider which party should claim the exemption for a dependent child.
Standard Deduction – For AMT purposes, there is not a standard deduction as there is with the regular tax computation. Thus, taxpayers affected by the AMT should always itemize. Granted that the benefit of some deductions will be lost, there is still a partial advantage. Even the smallest of charitable deductions will benefit at a minimum of 26% (the lowest bracket for the AMT).
Caution: Although not frequently encountered, incentive stock options (ISO) can have a profound impact on the AMT, and clients are strongly encouraged to seek advice prior to exercising incentive stock options.
The AMT is an extremely complicated area of tax law that requires careful planning to minimize its effects. Please contact this office for further assistance.
Just as the regular income tax allows personal exemptions, the AMT calculation allows an exemption, but it is based upon filing status. For the past several years, Congress has, on a year-to-year basis, increased that exemption for inflation. However, should they fail to provide an increase for 2012, the exemption amounts would revert to levels not seen since the early 2000s, which, depending upon filing status, would result in an approximate 30% to 40% decrease in the exemption amount. For example, the exemption amount for joint filers would drop from 2011's $74,450 to $45,000. The reduction of the exemption amount would snare a significantly greater number of taxpayers for 2012—estimated to be around 31 million, versus 4 million for 2011.
Other factors that can create an AMT for the average taxpayer include the following:
Medical Deductions – Medical deductions are allowed for the AMT computation, but only to the extent that they exceed 10% of a taxpayer's income. In contrast, the regular tax computation limit is a lesser 7.5%. (Starting in 2013, as part of the Health Care Act changes, the 7.5% will increase to 10% for regular tax also for taxpayers under age 65.) When a taxpayer knows that he is going to be affected by the AMT, it is sometimes possible to defer or accelerate medical expenses from one year to another, such as paying the orthodontist in installments or all at once. If your employer offers one, consider participating in a health flexible spending plan (FSA). It allows you to pay medical expenses with pre-tax dollars and avoid both the regular tax and AMT deduction limitations. However, starting in 2013, the maximum amount available for reimbursement of incurred medical expenses under the health FSA for a plan year (or other 12-month coverage period) cannot exceed $2,500 (adjusted for inflation beginning in 2014).
Tax Deductions – When itemizing deductions, a taxpayer is allowed to deduct a variety of taxes , including real property, personal property, and state income tax. But for AMT purposes, none of the itemized taxes are deductible. For most taxpayers, this represents one of their largest tax deductions and frequently triggers the AMT. If you are affected by the AMT, conventional wisdom would dictate deferring tax payments to a subsequent year when the AMT may not apply. When deferring, care should be exercised in regards to late payment penalties and interest on underpayments for certain taxes. In addition, taxpayers can annually elect to capitalize taxes on unimproved and unproductive real estate. This means foregoing the deduction currently and adding the tax paid to the cost basis of the real property.
Home Mortgage Interest – For both the regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a home or second home is deductible as long as the debt limit (generally $1.1 million) is not exceeded. This is true of refinanced debt, except that any increase in debt is treated as equity debt. For regular tax purposes, the interest on up to $100,000 of equity debt on the two homes can be deducted. However, equity debt is not deductible against the AMT, and neither is the acquisition or equity debt interest on a motor home or boat that qualifies as a second home. Therefore, taxpayers should exercise caution when incurring home equity debt. Generally, loan brokers are not aware of these limitations, and there are numerous pitfalls.
Miscellaneous Itemized Deductions – The category of miscellaneous deductions that includes employee business expenses and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this can create a significant AMT. Employees with significant employee business expenses should attempt to negotiate an "accountable" reimbursement plan with their employer. Under this type of plan, the reimbursement for qualified expenses is tax-free. Because the employee has been reimbursed, he or she no longer claims a deduction for the expenses, thus eliminating the miscellaneous deduction. Another strategy would be to defer the expenses to a year not affected by the AMT.
Personal Exemptions – Personal exemptions for dependents provide no benefit when taxed by the AMT method. Therefore, divorced or separated parents should carefully consider which party should claim the exemption for a dependent child.
Standard Deduction – For AMT purposes, there is not a standard deduction as there is with the regular tax computation. Thus, taxpayers affected by the AMT should always itemize. Granted that the benefit of some deductions will be lost, there is still a partial advantage. Even the smallest of charitable deductions will benefit at a minimum of 26% (the lowest bracket for the AMT).
Caution: Although not frequently encountered, incentive stock options (ISO) can have a profound impact on the AMT, and clients are strongly encouraged to seek advice prior to exercising incentive stock options.
The AMT is an extremely complicated area of tax law that requires careful planning to minimize its effects. Please contact this office for further assistance.
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