Avoiding the AMT Trap
by Alan L. Olsen, CPA, MBA (tax)
Greenstein Rogoff Olsen & Co. LLP
More and more taxpayers are finding a hidden tax on their individual tax returns. The alternative minimum tax (AMT) attempts to ensure that high income individuals who benefit from the tax advantages of certain deductions and exemptions will pay at least a minimum amount of tax. This tax was originally designed to keep taxpayers in higher income brackets from unduly taking advantage of tax driven policies by using:
- A lot of miscellaneous itemized deductions
- High local and state tax deductions
- Child exemptions
- A mortgage deduction
- Incentive stock options
The AMT has a different tax computation that adds back most deductions and compares the total with a specified exemption amount, creating a tax liability for an individual who would otherwise have paid little or no tax.
AMT Exemption Amounts (2011)
|AMT exemption|| |
|MFJ or QW||$74,450|
|Single or HOH||48,450|
|Exemption reduced by 25% of AMTI over:|| |
|MFJ or QW||$150,000|
|Single or HOH||112,500|
|Exemption eliminated at AMTI of:|| |
|MFJ or QW||$447,800|
|Single or HOH||306,300|
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 not 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 2011, but who will be in 2012, should accelerate expenses that are not deductible for AMT purposes into 2011. 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 2011 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. If you have incentive stock options, you may also realize AMT tax credits. If you have exercised incentive stock options and then suffered a subsequent drop in stock price, there is a new law that applies to AMT credit carryovers that may bring you some tax relief. For more details, read Alan Olsen’s article “New Relief for AMT Credit Carryovers.”
- 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.
- Claim Unused Minimum Tax Credits. There is a provision allowing minimum tax credits to be claimed even if the taxpayer continues to pay AMT rather than regular tax, preventing claiming of these credits. Taxpayers with unused minimum tax credits attributable to years before 2004 may get part or all of these credits refunded. Subject to income phase-out (234,600-357,100 for MFJ), these credits are refundable if less than $5,000 with the remainder claimed over the following 5 years or less if greater than $5,000.
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.