AMT: Always More Tax. Presented by Monica Haven, EA, JD, LLM

Transcription

1 AMT: Always More Tax Presented by Monica Haven, EA, JD, LLM

2 Life isn t fair! Us Them Wages & Taxable Investment Income ($) 59,350 0 AMT Taxable Tax-Free Income ($) 0 59,350 Adjusted Gross Income (AGI) 59,350 59,350 LESS: Deductions & Exemptions - 9,350-47,450 Taxable Income ($) 50,000 11,900 Regular Tax for Single ($) in ,681 0 Alternative Minimum Tax (AMT) in ,094 Effective Tax Rate (%)

3 Life isn t fair! Us Them Wages & Taxable Investment Income ($) 229,350 0 AMT Taxable Tax-Free Income ($) 0 229,350 Adjusted Gross Income (AGI) 229, ,350 LESS: Deductions & Exemptions - 9,350-47,450 Taxable Income ($) 220, ,900 Regular Tax for Single ($) in ,717 0 Alternative Minimum Tax (AMT) in ,932 Effective Tax Rate (%)

4 What we ll cover When did all this start? Who gets hit? What s the rationale? Do the math! What s different under the AMT? So, how do you plan?

5 Legislative History 1969: 155 individual taxpayers with incomes > $200K did not pay federal income tax!!! Tax Reform Act of 1969 created a minimum tax (10% add-on for income > $30K) designed to ensnare these tax evaders 1974: 244 high-income taxpayers had no income tax liability!!! Tax Reform Act of 1976 reduced the exemption ($10K), raised the tax rate to 15% Revenue Act of 1978 reduced top rate from 25 to 20%, left AMT exemptions unchanged

6 Legislative History (cont d.) 1978: New Code changes captured more than twice as many taxpayers and raised twice as much revenue Economic Recovery Tax Act of 1981 reduced top AMT rate from 25 to 20%; regular tax exemptions, standard deductions & brackets were indexed for inflation but AMT exemptions were not indexed Tax Equity and Fiscal Responsibility Act of 1982 added AMT preference items, raised exemption to $30K (Single) & $40K (MFJ), set rate at a flat 20%

7 Legislative History (cont d.) AMT is now a lucrative source of revenue: The number of affected taxpayers and revenues quadruples Tax Reform Act of 1986 added yet more preferences, created the exemption phase-out, & raised the AMT rate to 21% Omnibus Budget Reconciliation Act of 1990 raised AMT rate to 24% Omnibus Reconciliation Act of 1993 introduced bifurcated rates & exemptions still in effect today: 26% on incomes < $175K & 28% on incomes above $175K; $33,750 (Single) & $45,000 (MFJ)

8 Failure to Index for Inflation

9 Legislative History (cont d.) Exemptions were temporarily raised for Tax Technical Corrections Act of 1998 reduced capital gains rates for both regular tax & AMT Tax Relief Extension Act of 1999 allowed taxpayers to apply nonrefundable personal credits to their regular tax liability, even if they were subject to AMT Economic Growth and Tax Relief Reconciliation of 2001 allowed adoption, child, earned income & IRA credits Tax Hike Prevention Act of 2010 extended temporary AMT exemptions for 2 years

10 Legislative History American Taxpayer Relief Act of 2012 Exemptions in 2012 AMT exemptions set to $50,600 (S) & $78,750 (MFJ) Permanently indexed to inflation beginning in 2013 Exemption Phase-outs in 2012 Exemption reduced $1 for every $4 of AMTI > threshold amount $112,500 (S) & $150,000 (MFJ) Couple with AMTI of $175K $78,750 ¼ ($175, ,000) = $72,500 xmptn Complete phase-out at $314,900 (S) & $465,000 (MFJ) effective AMT rate = 35% Tax Rates in % $175,000 (S and MFJ) 28% on amounts > $175,000 (S and MFJ)

11 Rev. Proc Inflation-adjustments for 2013 Exemptions AMT exemptions set to $51,900 (S) & $80,800 (MFJ) Exemption Phase-outs $115,400 (S) & $153,900 (MFJ) Tax Brackets 26% $179,500 (S and MFJ) 28% on amounts > $179,500 (S and MFJ) Estimated cost of $1.8 trillion over next 10 years

12 Applicable AMT Rate & Exemptions Rate (%) /28 26/28 26/28 26/28 26/28 26/28 26/28 26/28 26/28 26/28 26/28 Exptn for MFJ 40,000 40,000 45,000 49,000 58,000 62,550 66,250 69,950 70,950 72,450 74,450 78,

13

14 A Mass Tax AMT was introduced as a class tax but is now a mass tax In 1990, AMT generated $1.6 billion in revenue; by 2006, AMT generated $23.9B In 2006, 3.5 M taxpayers were subject to AMT; one year later, 23.4M taxpayers were subject to AMT In 2012, AMT was expected to affect 35% of all taxpayers & raise 10% of total tax revenue BUT passage of ATRA took 30 million taxpayers off the AMT tax rolls! In 2013, it is estimated that 3.4 million taxpayers will be subject to AMT

15 Number of Taxpayers Affected by AMT Before & After ATRA [as per The Tax Policy Center of the Urban Institute & Brookings Institution]

16 Who will pay AMT?

17 AMT Tax Revenues Raised [as per The Tax Policy Center of the Urban Institute & Brookings Institution]

18 A Stealth Tax Since most taxpayers are unaware of its rules and widespread applicability, it is also a stealth tax It is a second tax system that runs parallel to the regular tax system Nevertheless, about 100 taxpayers with incomes > $1 million still did not pay any tax in 2001!

19 And still some taxpayers don t pay! [as per The Tax Policy Center of the Urban Institute & Brookings Institution]

20 Why assess AMT? Reduce perceived inequities Make everyone pay a fair share (or, at least, pay something) Correct flawed tax policies of regular tax system Eliminate abusive tax shelters Hide tax hikes

21 What s wrong with AMT? Added complexity (Form 6251, basis computations) Increased administrative costs (professional preparation, IRS processing) Reduced efficiency Convoluted planning opportunities Unnecessary filings (e.g., in 1998, 6.4M returns required AMT computations, 4M filers submitted Form 6251, but 3.4M did not owe any AMT!)

22 Reasons to Worry (Before ATRA) Regular tax rate reductions as regular tax rates drop below AMT rates, more taxpayers will be asked to pay their minimum share AMT not indexed for inflation as incomes continue to rise, more taxpayers will exceed the AMT exemption amounts Credits disallowed most tax credits used to reduce regular tax liability cannot be used to offset AMT liability This ultimately curtails Congress ability to provide tax incentives

23 Reasons to Worry (After ATRA) Is it really permanent? ATRA leaves deficit virtually unaffected!

24 Reasons to Worry (After ATRA) And projected AMT revenues will not fix the problem

25 Form 6251 (Part I: Compute AMTI)

26 Form 6251 (Part II: Compute AMT Tax)

27 Form 6251 (Part III: Compute AMT using CG rates)

28 Regular Tax Computation START with Adjusted Gross Income (AGI) = Income before Adjustments, Deductions and Exemptions SUBTRACT Adjustments o IRA contributions o Early withdrawal penalties o Self-employment Tax o Alimony paid o Moving Expenses SUBTRACT Deductions o Medical expenses o Mortgage interest o State, real estate, and personal property taxes paid o Charitable contributions o Unreimbursed employee business expenses o Legal fees and investments expenses SUBTRACT Personal Exemptions EQUALS Regular Taxable Income

29 AMT Computation Step 1: Calculate AMT tax base Regular taxable income + AMT preferences + AMT adjustments = AMT taxable income - Allowable AMT exemption = AMT tax base Step 3: Calculate Regular Tax liability for AMT purposes Regular Tax before credits - Taxes due to lump sum distributions - Regular Tax foreign tax credits = Regular Tax liability for AMT purposes Step 2: Calculate tentative AMT liability AMT tax base X AMT tax rate (26; 28% if > $175,000) = Pre-credit tentative AMT liability - Allowable AMT foreign tax credit = Tentative AMT liability Step 4: Calculate AMT tax due Tentative AMT liability [from Step 2] - Regular Tax liab. for AMT purposes [from Step 3] = AMT tax due (in addition to Regular Tax due)

30 Step 1: Adding Back Preferences & Adjustments Regular taxable income + AMT preferences + AMT adjustments = AMT taxable income - Allowable AMT exemption = AMT tax base

31 AMT Tax Preferences Items identified as potential sources of inordinate tax savings under regular tax but not permitted under AMT 1. Personal Exemptions none allowed TIP: AMT-affected taxpayers should donate exemption via multiple support agreement 2. Standard Deduction not allowed TIP: AMT-affected taxpayers should itemize deductions TIP: Make sure to calculate tax return both ways to ensure that total (not just AMT) tax liability is reduced

32 Tax Preferences (cont d.) 3. Medical Expenses must exceed 10% (versus only 7.5% of regular AGI 10% in 2013 & beyond) Taxpayer s regular AGI was $100K; medical expenses totaled $9K $1,500 could be deducted on Schedule A (= $9K less 7.5% of AGI) $0 deductible for AMT (= $9,000 less 10% of AGI) $1,500 deduction taken for regular tax is added back for AMT TIP: AMT-affected taxpayers should maximize use of all available pre-tax medical plans (HSAs, MSAs, etc.) 4. Taxes no deduction allowed for state/estimated taxes or DMV registration TIP: AMT-affected taxpayers should not pre-pay 4 th quarter ES or 2 nd property tax installment and should attempt to shift allowable expenses to Schedules C & E or capitalize taxes on unimproved land

33 Who pays the most?

34 Tax Preferences (cont d.) 5. Mortgage Interest allowed unless home equity loan is used for unrelated purpose TIP: AMT-affected taxpayers should pay off home equity loan or apply interest tracing rules for investment & business interest (which are deductible) 6. Charity deductions are limited to 20, 30, or 50% of regular (not AMT) AGI 7. Miscellaneous Deductions none allowed

35 AMT Adjustments Items that change the timing of when to recognize income and deductions (usually accelerate income and postpone deductions) 1. Incentive Stock Options (ISOs) no income is recognized upon exercise under regular tax, but bargain element must be added back for AMT TIP: Watch out for basis adjustments! When company stock was trading at $80/share, taxpayer exercised his option to purchase 500 shares at $24 each He must report an AMT adjustment on the bargain element, totaling $28K (= 500 shares X $80 less $24)

36 Adjustments (cont d.) 2. Depreciation add back excess depreciation claimed in early years and subtract shortage in later years. TIP: Basis must be tracked separately for regular and AMT purposes.

37 Adjustmemts (cont d.) 3. Tax-exempt Interest interest from private activity municipal bonds must be added back Issued by issued by state or local government Proceeds used for a defined qualified purpose by a private entity (e.g., stadium) 4. Capital gains qualified dividends must be added back TIP: Large capital gains may cause taxpayer to exceed AMT exemption amounts A married couple with three children has $100K ordinary income, $200K LTCG, $16K state/real estate taxes & $12K mortgage interest. The combined income is subject to AMT Taxpayers lose $11,285 of their exemptions, $4,815 of their itemized deductions, and $3,000 of their child tax credits under AMT This results in an additional tax of $4,937 (AMT) Thus, CGs were taxed at an effective rate of 21%, rather than 15%

38 Adjustments (cont d.) 5. State tax refund since state taxes are not deductible under AMT, state tax refunds are not taxable and are subtracted 6. Passive Activities most tax shelters will trigger an AMT consequence 7. Net Operating Losses (NOLs) a portion may be used to offset AMT

39 Facts NOL: Example In 2012, taxpayer reported the following income: $45K Wages (business) $65K Schedule C loss (business); includes $10,000 excess depreciation (AMT adjustment) $750 Interest (non-business) Total Income = $19,250 (regular); $9,250 (AMT) Taxpayer also claimed the following: $2,500 Traditional IRA contribution (non-business; AMT deductible) $3,500 State income tax withholdings (business) $2,200 Property taxes (non-business) $17,900 Mortgage interest (non-business; AMT deductible) Total Deductions = $26,100 (regular); $20,400 (AMT) Taxable Income = $45,350 (regular); $29,650 (AMT)

40 NOL: Example (Cont d.) Rules AMT NOL must be carried back to same year as regular NOL Election to forgo regular carry-back also applies to AMT carry-back AMT NOL deduction cannot exceed 90% of AMTI AMT NOL must be used before AMT exemption applied

41 Summary of Preferences & Adjustments [See APPENDIX A for complete table] Regular Income Tax (Form 1040) Alternative Minimum Tax (Form 6251) Type Standard Deduction Deduction for Personal Exemptions Home Mortgage Interest Can be deducted instead of itemized deductions. Not deducted. Note: No entry made on Form 6251 since form starts with income before standard deduction. Deduct the number of exemptions Not deducted. Note: No entry claimed multiplied by a set amount made on Form 6251 since form (adjusted annually). Deduction starts with income before partially phased out at higher deduction for personal income levels. exemptions. Qualified residence interest (QRI) to acquire or improve a principal and one second home(including certain boats and motor homes) and interest on a home equity loan of up to $100,000are deductible. Qualified housing interest, which is QRI (except interest on a second home that is a boat or motor home) and interest on a home equity loan, but only to the extent used to acquire or improve the residence, are deductible. If an eligible mortgage is refinanced, interest on any portion of the refinancing that exceeds the balance of the refinanced mortgage is not deductible. Exclusion Exclusion Exclusion

42 AMT Exemption Indexed for inflation beginning in 2010, but not adjusted for family size 2010: $47,450 (S) and $72,450 (MFJ) 2011: $48,450 (S) and $74,450 (MFJ) 2012: $50,600 (S) and $78,750 (MFJ) 2013: $51,900 (S) and $80,800 (MFJ) AMT exemptions are phased out for high-income taxpayers at a rate of 25 per dollar of AMTI over: o $112,500 in 2012; $115,400 in 2013 (Single) o $150,000 in 2012; $153,900 in 2013 (MFJ)

43 Step 2: Calculate Tentative AMT Liability AMT tax base X AMT tax rate (26; 28% if > $175,000*) = Pre-credit tentative AMT liability - Allowable AMT foreign tax credit = Tentative AMT liability * $179,500 in 2013

44 Allowable Tax Credits The Foreign Tax Credit may be used to reduce AMT tax liability, but not below 90% (although the credit is fully refundable under regular tax) All credits other than adoption, child, and IRA credits are allowed only to the extent that regular tax liability exceeds AMT liability

45 Step 3: Calculate Regular Tax Liability for AMT Regular Tax before credits - Taxes due to lump sum distributions - Regular Tax foreign tax credits = Regular Tax liability for AMT purposes

46 Step 3: Calculate AMT Tax Due Tentative AMT liability - Regular Tax liab. for AMT purposes = AMT tax due (add to Regular Tax due) NOTE: AMT is an add-on tax

47 AMT can hurt (real bad!) Taxpayer exercised ISO to purchase 100 shares at $25/share (when FMV of stock = $75/share). AMT adjustment = $5K ($50/share) His basis is $25/share for regular tax; $75/share for AMT Taxpayer later sells the stock for $40/share* Regular tax gain of $15K (= $40/share - $25/share) AMT tax loss of $35K (= $40/share - $75/share) BUT since excess capital losses are limited under both regular and AMT, taxpayer may only claim a $3K AMT loss! * To benefit from the LTCG rate, taxpayers must hold their shares for more than 1 year from date or 2 years from date of grant

48 Pay it forward Credit for Prior Year Minimum Tax (MTC) some of the current year AMT tax liability may be used to offset future regular tax liabilities if no new AMT is due [ ; extended under ATRA] Credit is limited to amount of AMT attributable to timing items (such as ISOs and depreciation) Unused credit may be carried forward Long-term MTC (from 3 or more years ago) may be partially refundable File Form 8801

49 Example of MTC Taxpayer has $8K MTC credit available from Taxpayer s regular tax liability in 2010 is $37K (his AMT liability would total $32K) Taxpayer does not have to pay AMT because his regular tax is higher Taxpayer may use $5K of his MTC from 2009 to reduce his regular tax in 2010 (= difference between regular and AMT liabilities in current year) Taxpayer may carry-forward remainder of unused MTC ($3K) to 2011

50 Form 8801 Part 1: Calculate AMT attributable to Excln Items Most Preferences are considered exclusion items and are not allowable when calculating the Minimum Tax Credit (MTC). Adjustments (deferrals) are allowed.

51 Form 8801 (Part II: Calculate Carry-forward Amount) The amount of MTC carryforward will generally equal the AMT that would have been attributable to adjustments (deferrals) only. To calculate: Subtract AMT attributable to exclusion items (Form 8801, Part I, Line 15) from AMT tax liability (Form 6251, Part II, Line 35).

52 Form 8801 (Part III: Compute AMT using CG rates)

53 Form 8801 (Part IV: Calculate Tentative Refundable Credit) Use Part IV to calculate refundable portion of MTC (if carry-forward 3 years).

54 State Tax Issues Some states conform to federal tax treatment, others do not California, for example, offers partial conformity: Exemptions: $62,420 (S) and $83,225 (MFJ) in 2012 Kiddie Tax Exemption: Earned Income + $6,950 in 2012 Tax Rate = 7% Business income is excluded from AMTI if gross income < $1 million Private Activity Bonds AMT Preference Item No AMT (or regular) NOL carry-back Make sure to check applicable state law!

55 Capital gains AMT Tax Strategies Revenues TIP: Time securities sales to avoid bunching large gains into 1 year Interest income TIP: Defer receipt of interest income by investing in short-term CDs and savings bonds which mature in next tax year Incentive Stock Options (ISOs) TIP: Exercise ISOs early in the year and sell the stock if FMV drops before year-end since no AMT adjustment is required if exercise and sale occurs in same year NOTE: Watch out for short-term tax consequences & weigh alternatives!

56 AMT Tax Strategies Expenses Decelerate deductions TIP: Don t pre-pay 4 th quarter state ES Itemize deductions TIP: Itemize even if Schedule A deductions < Standard Deduction if most deductions are not AMT preferences (e.g., charitable contributions or mortgage interest) Minimize employee business expenses TIP: Expenses reimbursed by employer are not subject to AMT adjustments

57 Get help IRS AMT Assistant offers simple test to determine whether taxpayers are subject to the AMT

58 The Future of AMT

59 Tax Reform? [as per

60 Monica Haven, E.A., J.D., L.L.M. (310) PHONE (310) FAX WEBSITE: The information contained herein is for educational use only and should not be construed as tax, financial, or legal advice. Each individual s situation is unique and may require specialized treatment. It is, therefore, imperative that you consult with tax and legal professionals prior to implementation of any strategies discussed.