When looking over your tax return, do you notice an amount on line 45? That amount is because you are subject to the alternative minimum tax. The Alternative Minimum Tax or AMT is an income tax that does not allow some of the tax preferences and deductions that regular tax computation allows. Basically, a punitive tax. When an AMT computation results in a higher tax, the higher tax applies. The additional tax from the Alternative Minimum Tax is added on line 45 of your return.
How the AMT is Determined
The AMT was originally designed nearly 50 years ago. It imposes a minimum tax on higher-income taxpayers who were avoiding taxes by claiming certain legal deductions or other tax benefits (also termed “preferences”). However, a number of taxpayers are now subject to the AMT. Why? Inflation.
What Triggers the Alternative Minimum Tax?
It’s complicated. To determine when an individual will be subject to the AMT because there are so many factors involved. For many, tax preferences can trigger the AMT either alone or in combination. The following are some of the items that frequently trigger the AMT for the average taxpayer:
Deductions for medical expenses are allowed for the AMT computation. However, only to the extent that they exceed 10% of the taxpayer’s income. The limit is through 2016. Even though the limit is 10% for regular tax purposes, taxpayers age 65 and over enjoy a lower limit of 7.5%. This leads to an AMT adjustment. Sometimes, it is possible to defer or accelerate medical expenses from one year to another. An example is paying an orthodontist in installments or all at once. If your employer offers a flexible spending plan, consider participating. These plans allow you to pay medical expenses with pretax dollars and avoid both regular and AMT deduction limitations.
Deduction for Taxes Paid
When itemizing deductions, a taxpayer may deduct a variety of other taxes. These includereal or personal property taxes and state income or sales taxes. However, for AMT purposes, none of these itemized taxes is deductible. For most taxpayers, this represents one of the largest tax deductions, and it frequently triggers the AMT. If the AMT affects you, conventional wisdom dictates deferring tax payments to a subsequent year when the AMT may not apply. When deferring, be careful. Late-payment penalties and interest on underpayments can be expensive. Also, taxpayers can elect to capitalize their taxes on a yearly basis. Examples are taxes for property improvements and unproductive real estate. This means letting go of the deduction and adding the tax paid to the cost basis of the real property.
Home Mortgage Interest
In regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a first or second home is deductible as long as it does not exceed the debt limit (generally $1 million). This is also 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 first two homes can also be deducted. However, equity debt is not deductible when computing the AMT; neither is acquisition or equity debt on a motor home or boat that may qualify 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 that includes employee business and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this often triggers the Alternative Minimum Tax. Employees with significant employee business expenses should try to negotiate an “accountable” reimbursement plan with their employers. Under this type of plan, reimbursement for qualified expenses is tax-free. An employee who receives reimbursement may not claim a deduction for those expenses. This eliminates the miscellaneous deduction. Another strategy is to defer the expenses to a year that the Alternative Minimum Tax does not affect.
The AMT computation does not allow a deduction for personal exemptions. In 2016 the deduction is $4,050 each for the taxpayer, his or her spouse (if any) and any dependents. Divorced or separated parents should carefully consider which party should claim the exemption for their children if one of the parents is subject to the AMT.
For regular tax purposes, taxpayers have the option of itemizing their deductions or taking the standard deduction. However, for Alternative Minimum Tax purposes, there is no standard deduction. So, taxpayer who ends up with an AMT when taking the standard deduction should try to force itemized deductions, even if the result is less than the standard deduction. The result will be an increase of the regular tax but a Alternative Minimum Taxr reduction. This could result in overall tax savings. Even the smallest of deductions will benefit those who are taxed at a minimum of 26%, the lowest bracket for the AMT.
Incentive Stock Options
Incentive stock options (ISOs) can have a profound impact on a taxpayer’s AMT. We are not saying this happens all the time, but it can happen. To achieve the beneficial long-term capital gains rates on stock acquired through an ISO, a taxpayer must hold the stock. Usually, for more than one year after exercising the stock option and two years after the option is granted. However, the difference between the fair market value and the option price must be added to the taxpayer’s Alternative Minimum Tax income in the year the option is exercised. To avoid this substantial AMT preference income, the taxpayer can sell the stock in the year that the option is exercised. They must also forego long-term capital gains rates. Alternatively, when doing so is beneficial, the taxpayer can exercise the option in small blocks over a period of years.
Taxpayers’ investments in businesses and partnerships sometimes provide tax incentives that the AMT does not allow. There is a long list of these incentives. The most common incentives are depletion allowances and intangible drill costs. Generally, these items appear on a Schedule K-1. The business activity issues to the investor and are then taxpayer’s includes it in the Alternative Minimum Tax calculation.
Need a Tax Attorney Who Knows the Alternative Minimum Tax Rules?
As you can see, the Alternative Minimum Tax can be an extremely complicated area of tax law. Careful planning is required to minimize its effects. Maybe you need a tax attorney who can answer all your questions. Contact Tom Holmes, JD, Chief Tax Specialist or Alex Franch, BS EA. Both of these professionals understands the complication behind AMT. Alex or Tom can consult you as to what the best route to take for your tax return will be in the upcoming tax year. Also, you may leave a comment below or go to our Facebook or Google Plus pages.
Sources and Resources
- Permanent AMT Patch
- Employment Lawsuit Won?
- Are Legal Expenses Tax Deductible? Part 2
- Should I Make An Estimated Tax Payment?