Tax Planning: Alternative Minimum Tax (Module 15)

Sam and Cindy are married and file a joint return. Their taxable income is $138,200, therefore their regular tax liability is $16,800. Their tax preference items are $24,800. AMT adjustments are excess depreciation of $18,000 and state and local property taxes of $10,000. What is their total tax liability?

$20,618 Taxable Income = 138200 Plus: Tax preferences = 24800 Plus: AMT adjustments = 28000 (excess dep plus taxes) Equals: AMTI = 191000 Minus AMT exemption = 111700 Equals: tax base = 79300 Multiplied: by tax rate = .26 Equals: Tentative minimum tax rate = 20618 Minus: regular tax = 16800 Equals: AMT = 3818 The total tax liability for Sam and Cindy is $20,618 ($16,800 regular tax + $3,318 AMT). $191,000 is their AMTI and $79,300 is their AMT tax base.

Jane Jenkins, a single taxpayer, has the following itemized deductions: - Home mortgage interest (first mortgage) = $17,200 - Charitable Contributions = $4,000 - State income taxes = $8,155 - Deductible gambling losses = $1,900 - Property Taxes = $13,890 - Deductible Margin Interest = $4,100 Jane's AGI for the current year is $245,400. Under the regular tax method Marcia is allowed itemized deductions of $49,245. What amount of itemized deductions, if any, would be allowed for purposes of the AMT?

$27,200 17200+4000+1900+4100 All are deductible except for taxes

Mrs. Richie (unmarried) has purchased various municipal bonds and tax-free mutual funds from you. She owns an expensive home (paid for) and gives to charity. At year end, her regular tax is $16,381. She asks you to review her tax return, and you have calculated that her AMT is $41,892. What is her AMT payable?

$41,892 - $16,381 = $25,511

What is the alternative minimum tax payable for the following situation? Bill and Linda Sanders are married and file a joint income tax return. They have estimated their regular tax to be $23,500 for the current year. What is their alternative minimum tax payable based on the following information? Adjusted gross income $150,150 Excess intangible drilling costs $22,000 Percentage depletion in excess of adjusted basis $14,250 Home mortgage note interest $11,500 AMT $33,384

$9,884 The difference between the AMT ($33,384) and the regular tax ($23,500) is the AMT payable ($9,884). The AMT ($33,384) is not the additional tax due.

What items are deductible for AMT purposes?

- Casualty and theft losses in excess of 10% of AGI - Charitable contributions - Medical Expenses in excess of 10% of AGI - Qualified housing interest - Estate tax deduction - Gambling losses - Deductible margin interest

Alternative minimum tax (AMT) adjustments represent what?

- Itemized deductions that are not allowed in computing AMTI, and - Timing differences relating to the deferral of income or acceleration of deductions.

Timing differences caused by deferring income or accelerating deductions include what?

- Real property placed in service after 1986 - Personal property placed in service after 1998 - Research and Experimental expenditures - Value of stock options under an ISO plan when exercised

What itemized deductions are not deductible for AMT?

- State, local and foreign income taxes - Real and personal property taxes

Individuals must use Form 6251 to compute the AMT. This form must be attached to an individuals tax return in what scenarios?

- an AMT tax liability actually exists - the taxpayer has tax credits that are limited by the tentative minimum tax - the AMT base exceeds the exemption amounts and an individual has AMT adjustment or tax preference items

What are three of the most common tax preferences items?

- excess of accelerated depreciation - tax-exempt interest on certain private activity bonds - exclusion of gain on the sale of certain small business stock

What tax credits are allowed to reduce the tentative minimum tax?

- foreign tax credit - child and dependent care credit - credit for the elderly and totally disabled - adoption expense credit - child tax credit - hope and lifetime learning credits - elderly and disabled credit

Which of the following should be considered to avoid or soften the impact of the AMT tax? 1. Spread out the exercise of ISOs over more than one year 2. Pay yourself a large bonus if you are the owner of a small corporation 3. Defer paying property taxes until next year 4. Buy private activity municipal bonds rather than public purpose municipal bonds

1, 2, 3 Buy public purpose municipal bonds (because the interest is not a preference item) rather than private purpose bonds (because the interest is a preference item).

Mr. Smith is subject to AMT. Which of the following can reduce his AMT payable? 1. Increasing his taxable income 2. Selling his home (with a large mortgage) and renting a home 3. Purchasing more municipal bonds (private activity) 4. Buying an oil and gas partnership 5. Paying off his existing large mortgage

1, 2, 5 If Mr. Smith increases his taxable income, he will pay more regular taxes. Selling his home and paying off his mortgage increase his regular taxes (less itemized deductions) and his AMT (which may or may not decrease AMT payable). Renting will eliminate the property tax deduction, thereby increasing his taxable income. Answer V is correct if the marginal tax bracket is higher than the AMT bracket (This assumes he itemizes his deductions). Although reducing or eliminating mortgage interest for ordinary income tax increases the income tax liability, it also increases AMT income. However, if the AMT bracket is higher than the taxpayer's ordinary tax bracket, then AMT payable actually increases (making Answer V wrong). Answer I and II (together) are not an answer choice, so you must choose the answer choice with I, II, and V. NOTE: Once you get well into the 37% bracket, it is difficult to trigger AMT. Why? Your regular tax rate is 37% versus the maximum AMT rate of 28%.

Which of the following are allowable tax credits to reduce tentative minimum tax? 1. Adoption credit 2. Child credit 3. Business Energy Credit 4. Earning income credit 5. Elderly and disabled credit 6. Hope scholarship credit 7. Foreign tax credit 8. Work opportunity credit

1, 2, 5, 6, 7

Which of the following are preference items or add-back items for purposes of the individual alternative minimum tax? 1. Qualified private-activity municipal bond interest 2. Property tax itemized deduction 3. The excess of percentage depletion over the property's adjusted basis 4. Cost depletion deductions

1,2,3 Cost depletion is not a preference item. Property tax is not a deduction. It is added back to calculate the AMT (an adjustment).

Steps in computing AMT

1. Adjust their regular taxable income by a number of adjustments and preferences. 2. Subtract an exemption amount to arrive at the AMT base. 3. Multiply the AMT base by the special AMT rates to compute the AMT. 4. Pay the greater of the regular income tax or the AMT.

What are the three most common characteristics of taxpayers who are subject to the AMT?

1. Taxpayers who have materially invested in real estate before 01/01/1999 are likely candidates for the AMT because they will have a large positive adjustment caused from the differences in depreciation 2. Taxpayers who use credits to reduce their regular tax liability may well be subject to AMT because one certain tax credits can reduce AMT 3. Taxpayers who have very large itemized deductions, primarily from large state and local taxes, may be subject to AMT because state and local taxes are not deductible for AMT purposes

Interest on which of the following bonds is (are) a preference item? 1. Municipal bonds 2. GO municipal bonds 3. Private activity municipal bonds 4. 30-year Treasury bonds 5. AAA corporate bonds

3 GO are general obligation bonds (public purpose). Municipal bonds could be private activity. Answer I could be correct. However, there was no Answer I and III. The Treasuries and corporate bond trigger more ordinary income, not a preference item.

Which of the following are preference items or adjustments for purposes of the alternative minimum tax? 1. Qualified housing interest 2. Investment interest expense in excess of net investment income 3. Qualified private activity municipal bond interest 4. The excess of depletion over the properties adjusted basis

3, 4 Private activity municipal bond interest and percentage depletion are preference items. Answer IV describes percentage depletion. Answer I is neither a preference item nor an add back item. The same is true with Answer II.

Mr. Terry has a taxable income of $200,000 (32% marginal bracket). He lives in New York paying high real estate taxes, high state and local taxes. As a result, he is always hit with a sizable tentative minimum tax (AMT) . What could he do to reduce his AMT? a. Increase his taxable income by earning more income or reducing itemized deductions. b. Sell his home. c. Move out of New York. d. Reduce his taxable income.

A If Mr. Terry increases his regular income tax liability, he decreases his AMT exposure. If he sells his house, his real estate taxes will disappear and he may still have add back items which are creating his AMT exposure.

To compute the tax base for AMT, tax preferences must be ________ to taxable income

Added To compute the tax base for the AMT, the tax preferences designated in section 57 must be added to taxable income

Mr. and Mrs. Lein want to lower their federal income tax exposure. Both of them work and their earned income is close to $200,000 after their 401(k) contributions. To reduce their tax liability they bought a large house with a substantial mortgage. They pay real estate taxes and local taxes. They donate generously to various charities. They cannot deduct for medical or dental expenses because of their AGI. As a result, their marginal tax bracket is 24%. When they got their 1040, they had an AMT hit of extra taxes at 26%. Most likely, what caused the AMT? 1. Real estate taxes 2. Mortgage interest 3. Local taxes 4. Charitable giving 5. AGI<

All AMT is calculated based on AGI. The itemized deductions reduce the regular taxes (interest and charitable donations). Indirectly, they trigger an AMT tax because they reduce the regular tax. Some items are added back (taxes). The answer to AMT reduction is generally to pay more regular tax.

Which itemized deduction is not added back to calculate the AMT? a. Real estate taxes b. Charitable giving c. Financial planning fees d. State income taxes

B

Which one of the following helps a taxpayer avoid paying AMT? a. Buy a larger home with a maximum mortgage. b. Exercise nonqualified stock options this year. c. Increase the amount of charitable gifting this year. d. Buy a larger home with more property taxes (pay the property tax this year).

B Exercising nonqualified stock options (NSOs) increases taxable income. Any tax item that increases the regular tax is correct for minimizing the AMT. Answers A, C, and D decrease regular taxable income and thus increase the exposure to paying AMT.

Which of the following is an AMT preference item? a. Personal exemption b. MACRS c. Standard deduction d. Municipal bond interest (public purpose) e. Cost depletion in excess of adjusted basis

B MACRS depreciation is a preference item. Percentage depletion is an AMT preference item, but cost depletion is not. Private activity bond interest is an AMT preference item, but interest on public purpose municipal bonds is not. It must say private activity. Personal exemptions have been suspended. Standard deductions are not part of the calculation (not usable). Add back items are not preference items.

Mr. and Mrs. Fair have been informed by their CPA that they are going to have to pay $28,000 of tentative minimum tax (AMT). Of the following, what activity could have caused the AMT? a. They purchased a large amount of a S&P 500 mutual fund. b. They purchased a large amount of public purpose municipal bonds. c. They donated a large amount of money to a public charity. d. They sold their house (gain $500,000) after living in it for 10 years. They invested the proceeds in balanced mutual funds.

C The substantial charitable donation reduces their regular income tax, thus increasing AMT exposure. Neither A or B affect AMT. Answer A is public Purpose. The S&P fund is tax efficient. Since they sold their house they are not itemizing, and that reduces AMT.

Mr. Snow doesn't understand AMT. The AMT is which of the following? a. A substitute for calculating the regular tax b. A method of avoiding calculation of the regular tax c. A separate method of calculating income tax liability d. Double taxation

C You might consider the AMT double taxation, but it is not. A separate method of calculating income tax liability is the best choice.

What deduction is not allowed when computing the alternative minimum tax? A. Standard deduction B. Moving expenses C. Individual retirement accounts D. Alimony

Correct Answer: A. Standard deduction Explanation: For purposes of the alternative minimum tax, no deductions are allowed for the standard deduction.

The alternative minimum tax applies to individuals, estates and trusts only if it exceeds the taxpayer's regular income tax liability. A. True B. False

Correct Answer: A. True Explanation: The alternative minimum tax only applies to individuals, estates and trusts if it exceeds the taxpayer's regular income tax liability.

Which of the following statements is false? A. The alternative minimum tax applies to individuals and estates and trusts only if the Tentative Minimum Tax exceeds the taxpayer's regular tax liability. B. The alternative minimum tax rate is equal to the taxpayer's top marginal tax rate. C. Most middle-income taxpayers are not subject to the alternative minimum tax. D. The alternative minimum taxable income is the taxpayer's regular taxable income adjusted for preference items, nondeductible items and other adjustments.

Correct Answer: B. The alternative minimum tax rate is equal to the taxpayer's top marginal tax rate. Explanation: Only the statement regarding the tax rates is incorrect. The AMT rates are 26% of the 1st $191,500 of AMT base and 28% of the balance, not the regular income tax rates.

Priscilla has calculated various components of her tax for the year. Her regular income tax is $17,000, her tentative minimum tax (TMT) for the year is $21,000, her alternative minimum tax (AMT) is $4,000 and her AMT tax credit earned this year is $2,500. What is Priscilla's tax liability for the year? A. $4,000 B. $18,500 C. $17,000 D. $21,000

Correct Answer: D. $21,000 Explanation: Priscilla's TMT exceeds her regular tax, so she will pay the $4,000 AMT plus the regular tax of $17,000. Therefore, her total tax liability is $21,000. The AMT tax credit will be used in future years when regular tax exceeds TMT.

Harry and Bev Latel both are earning high levels of compensation. As a result, they are high up in the 37% bracket. They pay a regular tax of around $325,000. They save regularly because they want to retire early. They currently rent a 1,500 square foot condo in downtown building. They drive their cars for 6-7 years. They only give a limited amount to various charities. However, they are not itemizing. They are claiming a standard deduction. They say they are aggressive investors, but mainly invest in low turnover growth funds. Do they appear to have an AMT problem? a. Yes, their income levels will trigger AMT. b. No, saving and investing their income will reduce their AMT. c. Yes, without itemizing their AMT will be excessive. d. No, without being able to itemize their AMT will not be a factor.

D Because they are not itemizing and there are no AMT preference or add-back items, they would have an AMT problem when they are in the 37% bracket. The AMT maximum tax is 28%.

A preference item for calculation of the AMT is which of the following? a. Medical expenses b. Personal exemptions c. Straight line depreciation d. Depreciation

D Straight-line is not a preference item.

AMT calculation examples

For example, Ricardo and Sue are married and file a joint return for 2019 with a regular taxable income of $30,000 and tax preferences and adjustments of $12,000. Their Alternative Minimum Taxable Income (AMTI) totals $42,000 ($30,000 + $12,000). Their alternative minimum tax base is zero because the AMT exemption amount is $111,700 for married individuals filing a joint return. Thus, their tax liability is based on the regular tax computation and no AMT liability is owed. Assume the same facts as above for Ricardo and Sue except that they have tax preferences and adjustments of $131,000. Their AMTI totals to $161,000 ($30,000 + $131,000). Their tax liability using the regular computation would be based on taxable income of $30,000, or $3,577. However, deducting the AMT exemption amount of $111,700 (2019) from AMTI leaves Ricardo and Sue with an AMT base of $49,300. Thus, their AMT tax is the 26% AMT tax rate times their AMT base of $49,300, or $12,818. Thus, Ricardo and Sue must pay $12,818 in tax because it is greater than their regular tax of $3,577.

AMT Credit

If a taxpayer pays AMT in a taxable year, that amount of AMT is eligible to be used as a credit, against the taxpayer's regular tax liability, in a future year.

Is qualified housing interest a preference item or adjustment for AMT?

No

Is depreciation and/or straight line depreciation a preference item?

Only depreciation

Timing difference example to avoid AMT with options?

Tom has ISO options for 1,000 shares of ABC Corp. The option price is $20 per share and the shares have a fair market value of $50 per share. On the exercise of the options, Tom has no ordinary tax liability but will generate $30,000 of AMT income, which will put him into an AMT situation. If Tom exercises half the options this year and half the options next year he will remain under the AMT limits. By timing his exercise of the options, Tom can save a substantial amount of AMT.

Alternative Minimum Tax (AMT)

a separate income tax code that began in 1969 to prevent the rich from not paying income taxes. It was not indexed to inflation and is now an extra tax burden on many upper middle class families

Tax preferences

are provisions in the Internal Revenue Code (IRC) granting favorable treatment to taxpayers. For example, accelerated depreciation allowed for real property placed in service before 1987 is a tax preference item. To compute the tax base for the alternative minimum tax (AMT), the tax preferences designated in Section 57 must be added to taxable income.

Alternative minimum taxable income (AMTI)

equals taxable income as modified by certain adjustments and increased by tax preference items.

MACRS (Modified Accelerated Cost Recovery System)

system used to determine the depreciation of assets for tax purposes

Tentative Minimum Tax

the tax on the AMT tax base under the alternative minimum tax system.