April 16, 2013

Alternative Minimum Tax

Credit: renjith krishnan
First of all, let me wish a happy end of “busy season” to all my Certified Public Accountant brethren out there who just finished the most stressful time of their year! Secondly, let me ask you: Did you have to file Form 6251?

Unless you have an incredible memory or were frighteningly thorough in reviewing your tax return, you may have already forgotten. If by some unfortunate twist, you, your tax software, or your accountant determined you actually owed Alternative Minimum Tax on Form 6251, you probably do remember that wretched form. Either way, even I, as a former tax preparer, have a white, hot hatred for the Alternative Minimum Tax, because it is an entirely parallel tax system that, in my opinion, has overreached its original intent.

You see, this mess all started when a predecessor, “Minimum Tax,” was enacted in 1969 when the federal government noticed that around 150 high-income taxpayers were not paying any taxes due to massive deductions and tax breaks. Congress addressed this national outrage by passing a bill that subjected around 19,000 taxpayers to an additional tax. The potential additional tax liability began in 1970, and was calculated as 10% of a taxpayer’s special tax preference items (certain deductions and tax breaks that had previously been allowed) that exceeded $30,000 in addition to their originally calculated tax liability. As most tax laws do, the “Minimum Tax” changed multiple times over the course of the 1970s and 1980s, and the most dramatic change occurred in 1982 when the “Minimum Tax” went away and the Alternative Minimum Tax (AMT), that we currently know and love, came into existence.

Whereas the “Minimum Tax” was an additional tax, AMT is a second tax system. To calculate AMT, you essentially start with your regular taxable income and add back quite a few deductions, credits, and exemptions, and then multiply your new AMT income by a rate between 26% and 28%.  In a nutshell, AMT is less generous than the normal tax system, and even according to the Internal Revenue Service, AMT is supposed to "limit the benefits that can be used to reduce total tax.” I wouldn’t begin to try to walk anyone through an entire tax system in a few paragraphs, but if you took fairly large deductions when compared to your income for state and local taxes, medical expenses, miscellaneous expenses, investment expenses, or mortgage interest to name just a few potential AMT-triggering items, you are going to want to be careful. In some cases, if you have passive income or passive losses, a net operating loss, foreign tax credits, or incentive stock options, you, too, could face AMT. The bottom line is that most individual filers with more than $50,000 worth of income and most married filing jointly taxpayers with more than $75,000 worth of income will need to figure out their tax liability under the normal tax system and the AMT system and be prepared to pay whichever is greater. (This surprisingly nice tool provided by the IRS can also help you decide if you will be required to pay AMT.)

Now as I’ve said before, I don’t do politics on 2MuchCents. However, I did make the “loaded” comment earlier that I believe AMT has overreached its original intent. What I meant is relative to the fact that in 1969, the government was going after 150 taxpayers; in 2011, around 4,000,000 taxpayers paid AMT and an estimated $39 billion was generated for the government by those taxpayers' additional liabilities. Don’t get me wrong, I’m for people earning their share and paying their share; I’m just not sure that the AMT that has evolved over the years (or could evolve in future years) is what the Congress of 1969 had in mind.

Not everything about AMT is doom and gloom, though. There are a few brighter spots. First, while the American Taxpayer Relief Act did not do a lot of things many people hoped it would do, it did permanently index some of the AMT parameters for inflation. While this will supposedly keep around 4 million taxpayers paying AMT annually, it is an improvement over the historical practice of always needing eleventh-hour congressional “patches” to increase AMT paramters for inflation that were annually reverting to their original 1982 amounts which, if left unchanged, would have caused millions more of Americans to face AMT consequences. Second, while AMT may not feel fair to you if you have to pay it, you are earning an AMT Credit. If you have ever previously had to pay AMT, and in the future you find your regular taxable liability is calculated to be higher than your AMT liability, then you could be allowed to reduce your regular tax liability down to the lower AMT liability, or by an amount equal to as much AMT as you have previously paid. It’s also worth mentioning that AMT credits are carried forward for an unlimited number of years.

To be completely honest, I always saved AMT calculations for last, like some rancid dessert, when I prepared individual tax returns and corporate tax returns. (Oh yes, there’s a corporate AMT as well, but I spared you from that!) AMT calculations could be complicated, confusing, and I never seemed to make anyone happy when I had to deliver the bad news that they faced Alternative Minimum Tax…

It’s my hope that you will look at Form 6251 a little closer next year. If you are an overachiever and look at your 2012 return and find that you are facing AMT or were pretty close, I would urge you to reach out to your CPA (or financial advisor) before their next “busy season” and after they’ve had a few weeks off because there are some planning strategies available that could save you from the dreaded AMT.


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