Alternative Minimum Tax Planning

April 13, 2006

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Because some taxpayers - particularly wealthy taxpayers - have been so successful in their efforts to legally minimize their tax bills, Congress came up with another way to tax them: the alternative minimum tax (AMT). The AMT provides a formula for computing tax that ignores certain preferential tax treatments and deductions that taxpayers would otherwise be entitled to claim.

So, many taxpayers are required to compute their income tax liability twice: once under the regular method and once again under the AMT method. An individual will be subject to the AMT if his or her AMT liability is more than the regular tax liability for the year.

Did You Know?

According to an April 2, 2004, Treasury Department news release, the AMT will continue to plague more and more middle-class taxpayers.

If the temporary tax cuts enacted in 2001 and 2003 are made permanent, the number of taxpayers subject to the AMT will increase from 3.3 million in 2004 to 16.2 million in 2005 and 46.4 million in 2014. In monetary terms, this translates to an estimated AMT increase to $28 billion in 2005 and $177.2 billion in 2014.

What types of things can trigger the AMT? The most common items that can cause you to become subject to the AMT are listed below. These items must be added back to your taxable income in order to compute your AMT:

all personal exemptions
the standard deduction, if you claimed it
itemized deductions for state and local income taxes, and real estate taxes
itemized deductions for home equity loan interest (this does not include interest on a loan to buy, build, or improve your home)
itemized deductions for miscellaneous deductions
itemized deductions for any portion of medical expenses that exceed 7.5 percent of AGI but not 10 percent of AGI
deductions you claimed for accelerated depreciation that exceed what you could have claimed under straight line depreciation (for property put into service in 1999 or later, this item will not apply to depreciable real estate, and it will generally apply only to 3, 5, 7, and 10-year property on which you claimed the ordinary MACRS depreciation)
differences between gain or loss on the sale of property for AMT purposes and for regular tax purposes; these differences most commonly occur as a result of the different depreciation methods required under AMT, as described above
addition of certain income from incentive stock options
changes in income from installment sales, since the installment sale method generally can't be used for AMT purposes
changes in certain passive activity loss deductions
deductions relating to oil and gas investments, or drilling or mining operations
interest on certain private activity bonds that would otherwise be tax-exempt

If you have large amounts of any items in this list, and your adjusted gross income exceeds the exemption amounts discussed below, you (or your accountant) should compute your AMT liability on IRS Form 6251, Alternative Minimum Tax - Individuals, to determine whether you must actually pay any AMT.

In an additional twist to this very complicated area, there is a tax provision that gives taxpayers back what the AMT otherwise takes away. Through the end of 2006, taxpayers may use nonrefundable personal credits to offset AMT liability. Nonrefundable personal credits include the dependent care credit, the credit for the elderly and disabled, the credit for interest on certain home mortgages, the Hope credit for certain college expenses and the Lifetime Learning credit.

Among the Business Tools are Form 1040 and Form 6251. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.

AMT rates and exemptions. The AMT method does provide each taxpayer with a flat dollar amount that is completely exempt from tax. The dollar amount of your exemption depends on your filing status. For 2005, the exemption amounts are $58,000 for marrieds filing jointly and surviving spouses; $40,250 for singles and heads of households; and $29,000 for marrieds filing separately.

For 2006, the Tax Increase Prevention and Reconciliation Act of 2005 increases the AMT exemption amounts to $62,550 for married individuals filing a joint return and surviving spouses, $42,500 for unmarried individuals, and $31,275 for married individuals filing separate returns. Although the AMT exemption amounts for individuals are increased for 2006, the threshold levels for the calculation of the phase-out remain unchanged.

If your taxable income for AMT purposes (called AMTI) exceeds the exemption amount, you will be subject to a 26 percent AMT rate on the first $175,000 of AMTI that exceeds the exemption amount, and a 28 percent rate on any AMTI above this $175,000 amount.

The AMT exemption amounts are phased out for taxpayers having AMTI exceeding specified income levels. Under these rules, exemption amounts are reduced by 25 percent of the amount by which an individual's AMTI exceeds $150,000 in the case of joint filers and surviving spouses, $112,250 for single taxpayers, and $75,000 for married taxpayers filing separately. The exemption available to married couples filing jointly and for surviving spouses is eliminated entirely if AMTI exceeds $382,000, $273,500 for single individuals, and $191,000 for married taxpayers filing separately.

Work Smart

There's no doubt about it - the AMT can play havoc with your tax planning. If your AMT liability and your regular tax liability tend to be approximately equal from year to year, your best bet is to maintain this stability. If your deductions are not so evenly spaced and you tend to have great fluctuations in income from year to year, you may be able to shift some AMT-triggering items from an AMT year to a non-AMT year, so as to reduce your liability in a non-AMT year almost to the point at which you would become subject to the AMT. Your tax professional can tell you whether this might be possible in your individual situation.

Credit for prior year's minimum tax. If you paid AMT last year, or you had a minimum tax credit carryforward from last year, you may be able to claim a tax credit for it.