Avoiding the AMT Trap
By Alan Olsen
Just to give you a sense of who might get caught by the Alternative Minimum Tax. If your joint income is below 150,000 you are allowed a 58,000 AMT exemption. What that means is that you can safely deduct up to 58,000 in deductions without incurring the AMT tax. However, once taxable income climbs above 150,000 the exemption is phased out by 25 cents for every dollar earned above that until finally at 382,000, there is no exemption at all. This year only 1.8 percent of married couples with two kids and an adjusted gross income between 75,000 and 100,000 will be subject to AMT. However, about 73% of the taxpayers earning income above 382,000 will experience AMT.
The following tax planning strategies should be reviewed to help individuals counter the AMT and plan successfully for their financial future:
- Acceleration of Ordinary Income. Individuals who expect to owe should consider accelerating ordinary and short-term capital gain income and deferring into the next year. Possible deductions to defer include state and local income taxes, real estate taxes, and miscellaneous itemized deductions subject to the two percent floor, which are not deductible under the AMT system. This planning technique is contrary to typical advice, but it may lower the ultimate tax bill.
- Acceleration of Expenses. Individuals who are not subject to the AMT in the current tax year, but who will be next year, should accelerate expenses that are not deductible for AMT purposes into this year. Also, they should consider selling private activity bonds and/or paying off home equity debt if the interest expense is not deductible for AMT purposes.
- Blend Tax Rates between years. Some of the differences between the AMT and regular tax systems are merely matters of the timing when deductions are taken. For instance, the AMT generally requires slower depreciation than is permitted for regular tax purposes. Other differences are permanent; for example, state income taxes can never be deducted under the AMT system, while under the regular system, they are deductible when paid. Paying AMT in one year may generate a credit against a future year’s regular tax, particularly when adjustments are due to timing differences. Overall, an individual may be better off if AMT is paid in a previous year in order to gain a credit in a later year. Perform a multi-year analysis to anticipate the effect of planning techniques used in the current year on future years.
- Stock Option Exercises. Consider whether any exercised incentive stock options should be disqualified (a disqualified disposition) before year-end to minimize the AMT liability, especially if the stock has dropped in value.
- Beware of the AMT Traps. Watch out for other AMT traps, such as income from private activity (municipal) bonds, which is taxable under the AMT. In addition, certain mortgage interest, such as from a home equity loan, is subject to AMT if the funds from the loan are not used to buy, build, or substantially improve a primary or second home.
- Utilizing Lower Capital Gain Rates. Taking advantage of lower capital gains rates can produce AMT implications in several situations, so be careful to consider the overall tax situation before taking any action. For example, the bargain element associated with the exercise of an incentive stock option is subject to AMT. Similarly, any large capital gain may raise your state and local taxes to a level that would trigger AMT. The resulting AMT could wipe out some or all of the benefit expected from the lower capital gains rate. This makes it particularly important to plan on a multiyear basis for transactions that could trigger the AMT.
- Perform an AMT self diagnosis. Falling victim to the AMT has many possible causes, but individuals may be particularly prone to AMT if any of the following issues exist:
– Large state and local tax deductions
– Large long-term capital gains
– Large deductions for accelerated depreciation
– Large miscellaneous itemized deductions
– Mineral investments generating percentage depletion and intangible drilling costs
– Research and development expenses
– An exercise of incentive stock options
– Tax-exempt income from private activity bonds
If one or more of these conditions affects you, you should discuss your AMT situation with your tax adviser, as soon as possible. Planning now will help net savings today, and it will best position individuals for the future.
Author: Alan Olsen
Alan Olsen is the managing partner at Greenstein Rogoff Olsen & Co., a top Bay Area CPA firm. He focuses on developing innovative strategies for business enterprises and individuals. A specialist in income tax planning, he frequently lectures and writes articles on tax issues for professional organizations and community groups. His website is ranked among the top in the nation for accounting firms, featuring tax tools and business leadership articles: http://www.groco.com