Bryant - Course 4. Tax Planning. 15. Alternative Minimum Tax Flashcards
(41 cards)
Module Introduction
In the past, many taxpayers carefully planned their financial affairs using these special tax provisions. They were able to thereby substantially reduce, or even eliminate, their entire income tax liability. As a result, new rules were implemented in 1969 to ensure that all taxpayers would pay at least a minimum amount of income tax. Thus, the Alternative Minimum Tax (AMT) was created.
The Alternative Minimum Tax (AMT) module will present to you the methods for calculating the alternative minimum tax for individuals and corporations.
Upon completion of this module you should be able to:
* Sequence the steps in the computation of AMT for individuals,
* List the adjustments affecting the AMT calculation,
* Specify tax filing procedures for AMT,
* Describe the process of computation of corporate Alternative Minimum Taxable Income (AMTI), and
* List the exemptions available to small businesses.
Previously, the alternative minimum tax (AMT) was referred to as an add-on minimum tax because it was added to the taxpayer’s regular income tax. The present AMT system was originally created in 1978. It is no longer an add-on tax and now functions as a separate and parallel tax system. Taxpayers are first required to compute their regular income tax liability, and then compute their tax under the AMT system.
The AMT system requires that taxpayers adjust their regular taxable income by a number of adjustments and preferences. An exemption amount is then subtracted to arrive at the AMT base. The AMT base is multiplied by the special AMT rates to compute the AMT. Taxpayers are required to pay the greater of either the regular income tax or the AMT.
The present AMT applies to individuals, corporations, estates, and trusts.
To ensure that you have an understanding of alternative minimum tax, the following lessons will be covered in this module:
* Individual Alternative Minimum Tax
* Trust Alternative Minimum Tax
The present Alternative Minimum Tax (AMT) system uses special methods of tax computation. Due to changes in the AMT calculations, a lack of any inflation adjustments for the AMT exemption, and the generally higher income of taxpayers, more and more taxpayers are either subject to AMT now or will be subject to AMT in the near future. Understanding this area of the tax system and being able to assist your clients in planning for AMT issues is vitally important for a financial planner.
At this point in time, however, most individual taxpayers are not subject to alternative minimum tax (AMT) because their regular income tax is greater than the AMT. This is because many taxpayers do not have substantial adjustments and/or preference items. Changes in the tax code, such as reductions of the regular marginal tax brackets, are making more taxpayers subject to AMT than before. Therefore, financial planners must be sensitive to AMT issues since a planning decision, which may be advantageous, could be disastrous if that decision places the taxpayer into an AMT situation.
AMT adjustments take into consideration itemized deductions and timing differences. Tax planning using AMT credit can help individuals to minimize or even avoid AMT liability. An individual whose tax computation results in AMT tax liability must follow the AMT tax filing procedures specified by the IRS.
To ensure that you have an understanding of individual alternative minimum tax, the following topics will be covered in this lesson:
* Computational Aspects
* Tax Preference Items
* AMT Adjustments
* Summary of AMT Computation
* Planning for the Alternative Minimum Tax
* AMT Tax Filing Procedures
Upon completion of this lesson, you should be able to:
* Determine whether an individual taxpayer is subject to AMT,
* Compute AMT for individuals,
* Calculate AMT with tax preferences,
* List the adjustments affecting AMT calculation,
* Specify the effect of itemized deductions and credit on AMT,
* Describe strategies for ATM planning, and
* Outline the procedures for AMT tax filing.
What are the Steps to Compute AMT?
- Step 1. Make Adjustments
Adjust regular taxable income by adjustments and preference items. - Step 2. Subtract Exemption
Subtract an exemption amount to arrive at the AMT base. - Step 3. Apply AMT Rate
Multiply the AMT base by the special AMT rates to compute the AMT. - Step 4. Determine Amount to Pay
Pay the greater of the regular income tax, or, the AMT.
Determining AMT Liability Example:
Ricardo and Sue are married and file a joint return for 2023 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 $126,500 (2023) 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 $3,160. However, deducting the AMT exemption amount of $126,500 (2022) from AMTI leaves Ricardo and Sue with an AMT base of $34,500. Thus, their AMT tax is the 26% AMT tax rate times their AMT base of $34,500, or $8,970. Thus, Ricardo and Sue must pay $8,970 in tax because it is greater than their regular tax of $3,160.
The terminology associated with this example is:
Regular tax liability = $3,160
AMT liability = $8,970
AMT payable = $5,810 ($8,970 - $3,160)
What is the formula for computing the alternative minimum tax (AMT) for individuals?
TAXABLE INCOME
Plus: Tax preference items (per IRC Section 57)
Plus: The standard deduction if the taxpayer does not itemize
Plus or minus: Adjustments are required because different rules are used for calculating the alternative minimum taxable income as compared with taxable income, such as special AMT limitations on certain itemized deductions.
Equals: Alternative minimum taxable income (AMTI)
Minus: Exemption amount (2023):
* $126,500 for a married couple filing a joint return and surviving spouses
* $81,300 for single individuals and Head of Household status
* $63,250 for a married individual filing separately
* $28,400 for trusts and estates
The exemption amount is reduced by 25% of AMTI in excess of:
* $1,156,300 for a married couple filing a joint return and surviving spouses
* $578,150 for single individuals, head of households, and for a married individual filing separately
* $94,600 for trusts and estates
Equals: Alternative Minimum Tax Base
Times: Tax rate:
26% of first $220,700 [MFJ, HoH, or Single]
28% of amounts in excess of $220,700 [MFJ, HoH, or Single]
Minus: Nonrefundable personal credits
Equals: Tentative Minimum Tax
Minus: Regular Tax (after nonrefundable personal credits)
Equals: Alternative Minimum Tax
Example of an AMT calculation:
The following are the details of Rita, an unmarried taxpayer filing single:
Taxable income = $185,000
Regular tax liability (after credits) = $45,497
Positive AMT adjustment due to limitations on itemized deductions = $25,300
Tax preferences in 2019 = $10,000
Rita has a nonrefundable adoption credit of $1,000 and a nonrefundable child and dependent care credit of $600
Rita’s alternative minimum tax for 2019 is calculated as follows:
Taxable income = $185,000
Plus: Tax preferences Items $10,000
Plus: Adjustments related to itemized deductions $25,300
Equals: Alternative minimum taxable income (AMTI) $220,300
Minus: Exemption $71,700
Equals: Alternative minimum tax base (AMT Base) $148,600
AMT 26% on first $194,800 of AMT Base $38,636
Plus: 28% on AMT Base over $194,800 $0
Equals: Tentative minimum tax $38,636
Minus: Regular tax ($45,497)
Alternative minimum tax (AMT payable) $0
What are Tax preferences items?
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 IRC Section 57 must be added to taxable income.
Some of the most common tax preference items include the following:
* Excess of accelerated depreciation (ACRS cost recovery) claimed over a hypothetical straight-line depreciation amount for real property placed in service before 1987, computed on an item-by-item basis.
* Tax-exempt interest on certain private activity bonds issued before 2009 or after 2010. In general, private activity bonds are state or local bonds that are issued to help finance private businesses.
* Exclusion of gain on the sale of certain small business stock. The exclusion is 7% of the gain on the disposition of qualified small business stock under Section 1202.
All items receiving preferential treatment are not all tax preference items. For example, most municipal bond interest income is exempt from the federal income tax but is not a tax preference item. Only tax-exempt interest on private activity bonds issued after August 7, 1986 but before January 1, 2009 is subject to the AMT. Also, bonds issued by a municipality to fund certain nongovernmental activities such as industrial parks are subject to AMT. The interest on such bonds is tax-exempt for ordinary tax calculations but is taxable under AMT. This is one area where planning for AMT is important because liability for AMT will transform a tax-exempt investment into a taxable one.
Over the years, tax preference items have played a diminishing role in creating AMT, while tax adjustments, which we will see next, have become the primary AMT generator. Therefore, most taxpayers will not have tax preference items.
Tax Preference Items Example:
Richard, a single taxpayer, has the following tax preference items for the current year:
* $15,000 ACRS cost-recovery deduction on real property placed in service before 1987 and held for investment. The straight-line ACRS deduction would have been $10,000.
* $10,000 of tax-exempt interest on private activity bonds.
What is Richard’s total tax preference?
Richard’s total tax preferences are $15,000, consisting of:
* $5,000 excess cost recovery deductions, and
* $10,000 tax-exempt interest on the private activity bonds.
To compute the tax base for AMT, tax preference items must be __ ____??____ __ taxable income.
* added to
* subtracted from
added to
To compute the tax base for AMT, tax preference items designated in Section 57 must be added to taxable income.
List items that are deductible for alternative minimum tax (AMT) purposes
Only certain itemized deductions are allowed in computing alternative minimum taxable income (AMTI). Additionally, the standard deduction is not allowed if an individual does not itemize deductions.
The following items are deductible for alternative minimum tax (AMT) purposes:
* Casualty and theft losses in excess of 10% of Adjusted Gross Income (AGI) (ONLY VALID FOR FEDERAL DECLARED DISASTER AREAS)
* Charitable contributions (but not in excess of the 20%, 30%, 50%, and 60% of AGI limitation amounts)
* Medical expenses in excess of 7.5% of AGI
* Qualified housing interest
* Certain other interest up to the amount of qualified net investment income included in the AMT base
* Estate tax deduction on income in respect of a decedent
* Gambling losses (to the extent of gambling winnings)
List items that are NOT deductible for alternative minimum tax (AMT) purposes
Some of the more significant itemized deductions that are not deductible for the AMT include:
* State, local and foreign income taxes ($10,000 maximum), and
* Real and personal property taxes.
Some tax advisors recommend that cash-basis taxpayers prepay their local property taxes or state income taxes before the end of the year. This would reduce the current year’s tax liability. However, if the taxpayer is subject to the AMT, this may not be a valid strategy.
Jane, a single taxpayer, has the following itemized deductions:
Home mortgage interest (first mortgage): $17,200
Charitable contributions: $4,000
State income taxes: $8,100
Deductible gambling losses: $1,900
Property taxes: $13,900
Deductible margin interest: $4,100
Jane’s AGI for the current year is $245,400. What amount of itemized deductions would be allowed for purposes of the AMT?
* $27,200
* $49,200
* $35,300
* $31,200
$27,200
All of the listed items are deductible under AMT except for the taxes (state & property).
Home mortgage interest (first mortgage): $17,200
Charitable contributions: $4,000
Deductible gambling losses: $1,900
Deductible margin interest: $4,100
$17,200 + $4,000 + $1,900 + $4,100 = $27,200
List 4 of the most common alternative minimum tax (AMT) adjustments for individuals due to timing differences.
- For real property placed in service after 1986 and before January 1, 1999, the difference between the modified accelerated cost recovery system (MACRS) depreciation claimed using the property’s actual recovery period and a hypothetical straight-line depreciation amount calculated using a 40-year life.
- For personal property placed in service after 1998, the difference between the MACRS deduction and the amount determined by using the 150% declining balance method under the alternative depreciation system with a switch to the straight-line method.
- For research and experimental (R&E) expenditures, the difference between the amount expensed and the deduction that would have been allowed if the expenditures were capitalized and amortized over a ten-year period.
- For the deferral of taxability on the exercise of options received under an Incentive Stock Option plan. This is an area of particular importance to financial planners because the timing of the exercise of ISO options is usually discretionary. A choice to exercise ISO options when the taxpayer is subject to AMT or will become subject to AMT because of the exercise could create a large and unexpected tax liability, which can usually be avoided or diminished with careful tax planning.
AMT Adjustments Example:
Rob has the following AMT adjustments caused by timing differences in 2023:
Rob has a residential rental property costing $100,000. This property was placed in service in January 1999. The depreciation in 2022 on this property is $3,636. This depreciation has been calculated using the straight-line method, a 27½ recovery period, and based on MACRS rules. The depreciation in 2023 for AMT purposes is $2,500. This is based on the straight-line method and a 40-year recovery period, under the alternative depreciation system. Thus, the positive AMT adjustment is $1,136 ($3,636 - $2,500). The Taxpayer Relief Act of 1997 eliminates this adjustment for real property that is placed in service after 1998. Such property is depreciated under the straight-line method.
A computer used in business costs $10,000. It was placed in service in 2023. The depreciation on this computer is $2,000. The depreciation is based on MACRS rules, which require a 200% declining balance method, a half-year convention, and a five-year recovery period. The depreciation for AMT purposes is $1,500. It is based on the alternative depreciation system, that is, 150% DB method, half-year convention, and a five-year recovery period. Thus, the positive AMT adjustment is $500 ($2,000-$1,500).
R&E expenditures amounting to $50,000 are expensed in the current year. For AMT purposes, the R&E deduction would be $5,000 ($50,000, 10 years). This is because the expenditures are capitalized and amortized over a 10-year period. Thus, the positive AMT adjustment is $45,000 ($50,000 - $5,000).
Rob’s total positive AMT adjustment to his taxable income in 2023, to arrive at AMTI, is $46,636 ($1,136 + $500 + $45,000).
What personal credits are allowed to reduce the tentative minimum tax?
A number of credits are allowed to reduce a taxpayer’s regular tax liability. However, for purposes of the alternative minimum tax (AMT), only the foreign tax credit and nonrefundable personal 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
* AOTC and Lifetime Learning credits
Describe the alternative minimum tax foreign tax credit
The foreign tax credit that may be deducted from the AMT is a specially computed credit, called the “alternative minimum tax foreign tax credit.” It is calculated using the various amounts used in computing AMTI rather than taxable income. Thus, the AMT is likely to apply to a taxpayer who uses credits (other than foreign tax credits and nonrefundable personal credits) to reduce his regular tax liability.
For the purposes of AMT, certain credits are allowed which reduce the tentative minimum tax. Identify each of the allowable credits (Select all that apply)
* Adoption Credit
* Child Tax Credit
* Business Energy Credit
* Earned Income Credit
* Elderly and Disabled Credit
* American Opportunity Tax Credit
* Foreign Tax Credit
* Work Opportunity Tax Credit
- Adoption Credit
- Child Tax Credit
- Elderly and Disabled Credit
- American Opportunity Tax Credit
- Foreign Tax Credit
Explaind the AMT Credit
Taxpayers are allowed an alternative minimum tax (AMT) credit that can be used against their regular tax liability, under IRC Section 53. 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.
Though this may seem unusual, there is underlying reasoning for the AMT credit. The AMT is caused primarily by adjustments that will reverse in the future. The taxpayer will actually pay a higher regular tax in those future years. Therefore, the imposition of a prior year AMT, and the current year regular tax, would constitute double taxation. A taxpayer may have paid AMT in prior years, but is not subject to the AMT in the current year. Such a taxpayer may be entitled to an AMT credit against his regular tax liability in the current year.
When can AMT credit that becomes available in future years be used?
It is extremely important to note that an AMT credit may be available in future years to offset any regular tax that is owed. Any AMT credit that becomes available in future years can only be used when the regular tax exceeds the AMT tax. If the AMT tax exceeds the regular tax in future years, the credit would not be used and would carry over to the following year.
Exam Tip:
Understand the Alternative Minimum Tax (AMT) basics. The AMT system requires taxpayers to follow what steps:
- Adjust regular taxable income by adjustments and preferences.
- Subtract an exemption amount to arrive at the AMT base.
- Multiply the AMT base by the special AMT rates to compute the AMT.
- Pay the greater of the regular income tax or the AMT.
What are things to consider for Alternative Minimum Tax Planning?
Taxpayers with substantial amounts of tax preference items, and a corresponding low regular tax liability may be subject to the alternative minimum tax (AMT). These taxpayers need to engage in tax planning to minimize or avoid the AMT. A liberal exemption is provided for most individuals, that is, $126,500 (2023) for married individuals filing a joint return and $75,900 (2023) for single taxpayers and heads-of-households. The timing of certain income and deduction items may result in the full use of the exemption each year.
Planning to avoid the AMT may be accomplished by delaying the payment of certain itemized deductions.
* For example, state and local taxes are itemized deductions that reduce the regular income tax but do not reduce the AMT. A taxpayer using the cash method of accounting, who defers the payment of state income taxes into the following year, triggers an increase in the regular tax for the current year. This increase can eliminate AMT liability. However, it is necessary to consider the tax effects for both the current and following years. The reason is that state income taxes are deductible for purposes of the regular tax calculation when the payment is made in the following year. This reduction may affect the AMT calculation in such a year and increase the amount of tax that is owed. Similarly, as noted above, the time of the exercise of ISO options may be used to reduce or eliminate the AMT.
Certain tax-exempt investments generate additional tax preferences for the investor, such as interest on private activity bonds. An investor must determine the impact of such investments on his or her AMT before acquiring them.
If a taxpayer was already subject to AMT, then the optimal strategy would be to accelerate income into the AMT year and delay allowable itemized deductions until a regular tax year. Any income would be taxed at 26% or 28% rather than at a higher rate, while any deferred deductions (such as charitable contributions) might allow a deduction at a rate greater than 28%. However, care must be taken when utilizing this strategy. A taxpayer should not accelerate too much income into the AMT year or defer too many deductions into a regular tax year. A taxpayer should only accelerate income and defer expenses up to the point where tax liability under AMT equals the regular tax.
What are the important AMT Tax Filing Procedures?
Individuals must use Form 6251 to compute the alternative minimum tax (AMT).
Form 6251 must be completed and attached to an individual’s tax return in any of the following situations:
* 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.
Section One Summary
Tax laws give preferential treatment to certain types of income and allow special deductions on some kinds of expenses. Many individuals benefit from these tax advantages. The alternative minimum tax (AMT) regulation attempts to ensure that all individuals will pay at least a minimum amount of tax.
In this lesson, we have covered:
* AMT computation: The basic steps in AMT computation are:
- Adjust regular taxable income with preferences and adjustments.
- Subtract an exemption amount to arrive at the AMT base.
- Multiply the AMT base by AMT rates to compute the AMT (but using the lower rates of 0%, 15%, or 20% for certain capital gains and dividends).
- Pay the greater of two: the regular income tax, or the AMT.
* Tax preferences are certain items where special considerations are given to taxpayers according to the tax law. They include:
- Excess depreciation over straight-line depreciation,
- Tax-exempt interest on certain private activity bonds, and
- Exclusion of gain on the sale of Section 1202 small business stock.
* AMT adjustments represent:
- Itemized deductions that are not allowed in computing AMTI, and
- Timing differences relating to the deferral of income or acceleration of deductions.
-
Itemized deductions allowed for AMT adjustment are:
Charitable contributions,
Medical expenses in excess of 7.5% of AGI,
Qualified housing interest,
Estate tax deduction on income in respect of a decedent, and
Gambling losses, to the extent of gambling winnings. - Timing differences caused by deferring income or accelerating deductions include the following:
- 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
- Credits that reduce the AMT: Foreign tax credit and nonrefundable tax credits. The nonrefundable credits are Child and dependent care credit, Elderly and totally disabled credit, Adoption expense credit, Child tax credit, and the American Opportunity and lifetime learning credits.
- AMT credit can reduce regular taxes paid on future tax returns. An AMT credit can only be used when the regular tax liability exceeds the AMT liability.
- Tax planning for avoiding AMT or minimizing it requires that taxpayers correctly time certain income and deduction items. They can thus make full use of the exemption each year.
-
AMT tax filing procedures stipulate that individuals must use Form 6251 and attach it to his or her tax return, if:
The taxpayer is subject to AMT tax liability.
The taxpayer has tax credits limited by the tentative minimum tax.
The taxpayer has AMT adjustments or tax preference items and the AMT base exceeds the exemption amounts.
