SOME PLANNING FOR INDIVIDUAL TAXPAYERS
ince 1969 the Internal Revenue Code has included an alternative minimum tax (AMT), originally designed to prevent wealthy taxpayers from claiming so many deductions that they wound up paying little or no taxes.
Under the AMT, taxpayers with large amounts of regular tax deductions and credits (known as “preferences”) have to add back these preferences, subtract flat exemption amounts, adjust for long-term capital gains taxes and recompute the tax (under a two-tiered rate) on the totals. If the result is more than their regular tax liability (before certain credits), they must pay this amount in addition to their regular tax liability.
Preferences that must be added back include (but are not limited to) the standard deduction, personal exemptions, a portion of medical expenses, state and local taxes, some mortgage interest, a portion of miscellaneous itemized deductions, net operating loss deductions, passive income or loss deductions, a portion of accelerated depreciation and some income from the exercise of incentive stock options. Exemption amounts differ, depending on the taxpayer’s filing status, and are phased out if AMT income exceeds certain limits.
Because so many of the dollar amounts used in calculating the AMT were not indexed for inflation until recently, and because more and more credits and allowances that lower regular tax liabilities have been added to the tax code, an increasing number of middle-income taxpayers are finding themselves liable for the AMT this year. These individuals are looking for legitimate ways to minimize (or avoid) this additional tax.
Taxpayers should first understand whether they are at risk for the AMT. Then they should understand which credits and incentives affect this determination.
Note that any AMT planning should involve multiyear projections, to determine both the regular tax and AMT liabilities over a number of years and to decide what actions will provide the best results over the long run.
Postpone (or prepay) some itemized deductions. If there are regular tax deductions that will be added back for AMT purposes and that a taxpayer has flexibility in paying (for example, state and local taxes), delay paying these taxes until next year to avoid a current-year AMT liability. Likewise, if a taxpayer is not subject to AMT in the current year but likely will owe AMT next year, he or she might try to manage that AMT liability and consider prepaying some of next year’s state and local taxes.
Some employees may be able to negotiate with their employers for earlier payments of income that would normally be paid shortly after yearend (such as bonuses). By doing this a taxpayer may be able to have this income taxed at whichever rate (AMT or regular tax) is lower for a given year.
Pay off home-equity loans where the proceeds were not used to improve the home. The only mortgage interest eligible for AMT purposes is from a mortgage whose proceeds were actually used to build, buy or substantially improve a taxpayer’s main or second home. If a taxpayer has taken a home-equity loan and used the proceeds to pay off credit card debt, go on vacation or buy a new car, the interest is not deductible for AMT purposes.
For more information, see Darla Decore, CPA, and Amy Leach, CPA, Tax Clinic, “Navigating the AMT,” in the April 2006 issue of The Tax Adviser.
The Tax Adviser
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