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Alternative Minimum Tax Planning

Because some particularly wealthy taxpayers were so successful in legally minimizing their tax bills back in the last 1960s, Congress came up with another way to tax them: the alternative minimum tax (AMT). The AMT provides a formula for computing tax that ignores certain preferential tax treatments and deductions that taxpayers would otherwise be entitled to claim and imposes a tax on this alternative minimum taxable income. The AMT is owed in addition to all other tax liability the taxpayer owes. Thus, if the AMT liability is higher than regular tax liability, then the individual will be subject to the AMT: the amount of AMT tax owed is added to the regular tax owed.

Because the AMT exemption levels had lagged far behind inflation and other tax rate adjustments, AMT liability began to affect middle-income taxpayers, not the super-rich for which it was originally intended. This meant that many taxpayers were required to compute their income tax liability twice: once under the regular method and once again under the AMT method. Rather than fixing the system properly, Congress embarked on annual ritual of temporary patches. After more than 40 years, Congress finally included a permanent fix in the American Taxpayer Relief Act of 2012.

AMTI is the individual's regular taxable income recomputed with certain adjustments and increased by certain tax preferences. However, a specified amount of AMTI is exempt from AMT based on the taxpayer’s filing status and the tax year involved.

AMT Exemption Amounts. A specified amount of income is exempt for AMT. If your income is below the exemption amount, you are home free--even if you have tax preference items. The exemption amounts are now indexed for inflation, so it is less likely that middle-class taxpayers will fall into the AMT abyss.

For 2012, the exemption rates are

  • $50,600 for an unmarried individual not a surviving spouse
  • $78,750 for joint return filers or a surviving spouse
  • $39,375 for married individuals filing separately

AMT Exemption Phaseout. In keeping with the Congressional purpose to extract tax from high-income individuals, the AMT exclusion amount is phased out as one's income increases. Thus, the exemption amount is reduced by 25 percent for each $1 of alternative minimum taxable income (AMTI) in excess of: (1) $112,500 in the case of unmarried individuals, (2) $150,000 in the case of married individuals filing a joint return and surviving spouses, and (3) $75,000 in the case of married individuals filing separate returns.

AMT preferences and AMT Income computation. The most common items (preferences) that can cause you to become subject to the AMT are listed below. These items must be added back to your taxable income in order to compute your AMT:

  • all personal exemptions
  • the standard deduction, if you claimed it
  • itemized deductions for state and local income taxes, and real estate taxes
  • itemized deductions for home equity loan interest (this does not include interest on a loan to buy, build, or improve your home)
  • itemized deductions for miscellaneous deductions
  • itemized deductions for any portion of medical expenses that exceed 7.5 percent of AGI but not 10 percent of AGI
  • deductions you claimed for accelerated depreciation that exceed what you could have claimed under straight line depreciation (for property put into service in 1999 or later, this item will not apply to depreciable real estate, and it will generally apply only to 3, 5, 7, and 10-year property on which you claimed the ordinary MACRS depreciation)
  • differences between gain or loss on the sale of property for AMT purposes and for regular tax purposes; these differences most commonly occur as a result of the different depreciation methods required under AMT, as described above
  • changes in income from installment sales, since the installment sale method generally can't be used for AMT purposes
  • changes in certain passive activity loss deductions
  • deductions relating to oil and gas investments, or drilling or mining operations
  • interest on certain private activity bonds that would otherwise be tax-exempt

If you have large amounts of any items in this list, and your adjusted gross income exceeds the exemption amounts discussed below, you (or your accountant) should compute your AMT liability on IRS Form 6251, Alternative Minimum Tax - Individuals, to determine whether you must actually pay any AMT.

AMT Rate. An individual's tentative AMT is generally equal to the sum of:

  1. 26 percent of the first $175,000 of the taxpayer's alternative minimum taxable income (AMTI) ($87,500 for a married taxpayer filing a separate return); and
  2. 28 percent of the taxpayer's remaining AMTI.

Nonrefundable personal tax credits For tax years beginning after 2011, all nonrefundable personal tax credits are allowed to the full extent of the taxpayer's regular tax and AMT liability This means that these tax credits directly offset AMT tax as well as regular tax. These credits are the:

  • child tax credit;
  • American Opportunity tax credit;
  • retirement savings contributions credit;
  • residential energy efficient property;
  • small plug-in electric vehicles credit;
  • alternative motor vehicle credit; and
  • new plug-in electric drive motor vehicles.

Business Tools

Among the Business Tools are Form 1040 and Form 6251. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.

Think Ahead

Work Smart

There's no doubt about it - the AMT can play havoc with your tax planning. If your AMT liability and your regular tax liability tend to be approximately equal from year to year, your best bet is to maintain this stability. If your deductions are not so evenly spaced and you tend to have great fluctuations in income from year to year, you may be able to shift some AMT-triggering items from an AMT year to a non-AMT year, so as to reduce your liability in a non-AMT year almost to the point at which you would become subject to the AMT. Your tax professional can tell you whether this might be possible in your individual situation.

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