Alternative Minimum Tax (AMT) is a confusing subject for most clients and, if they are required to pay, it can be a frustrating one. So, how can a client know if they may be subject to owing AMT? chances are higher if you paid it last year, you may owe again this year. Also, if you have some of the deductions on your regular tax liability that are listed below, your chances of owing AMT increase.
The percentage of people that are required to pay AMT has only been increasing over the last decade. From 2000 to 2010 the amount of people earning between $200,000 and $500,000 that owed AMT has increased from almost 19% to 64%. AMT was established in 1969 to prevent the taxpayers that were considered wealthy by Congress from using different tax shelters to avoid substantial federal tax liabilities. But, this tax is affecting more and more taxpayers because it does not adjust for inflation.
AMT essentially forces the taxpayer to calculate their tax twice, once following regular income tax rules and again using AMT rules; you are then required to pay the higher of the two tax liabilities. There are dozens of deductions that are allowable forregular taxes but are not deductible for AMT purposes, which will increase your taxable AMT income.
Itemized deductions are AMT’s first concern. If you have taken the standard deduction, you must add that back into AMT taxable income. If you have instead elected to take itemized deductions, you must go through each section and review which of those deductions can and cannot be used for AMT purposes.
Medical expense deductions are held to a higher threshold, meaning that for it to be eligible it must be higher than 10% of your adjusted gross income, compared to the regular tax, it is a 2.5% increase.
You cannot take deductions for taxes such as state and local income or real estate paid throughout the year. But, due to the fact that you are not allowed this deduction, you are also not required to report state tax refunds as taxable income for AMT.
You are allowed to take a deduction for home mortgage interest paid, so long as the loan relates directly to buying, building, or improving your home. If the loan was used to purchase something such as a car, this is not deductible for AMT. Along the same lines, miscellaneous itemized deductions are not deductible for AMT, the main one being the employee business expenses.
Other areas that are directly related to AMT are interest income, incentive stock options, and passive activities. These topics all have unique rules that will create differences between regular and AMT tax.
There are some areas that will reverse themselves over time, depreciation and long term contracts, are two topics that create differences between AMT and regular tax. But by the time these have been
fully realized the difference between the two types of tax will be zero, and they are referred to as timing differences.
Once you have gone through these areas, you are able to take an AMT exemption, which is phased out as income increases. For married couples the exemption starts at $74,450 for 2011, but gets reduced if your AMT income is over $150,000. For a single person the exemption is $48,450, but gets reduced if your AMT income is over $112,500.
AMT has several other differences from regular tax that can be seen on Form 6251, used to calculate Alternative Minimum Tax. Each client’s tax situation is unique, and there are tax planning strategies that can help to make the best of AMT. For more information about AMT or help with tax planning for AMT, please give us a call. We’d be happy to help you understand what impact your Alternative Minimum Tax could have on your next tax return!