Tax Guide: Alternative Minimum Tax

The purpose of the AMT is to prevent taxpayers who enjoy certain tax benefits from avoiding a minimum tax liability on their income. The computation of the AMT is based on regular taxable income, which is then increased by certain tax preference items, increased or decreased by certain adjustments, and reduced by an exemption amount. The exemption amount is $45,000 (for married taxpayers filing jointly), $22,500 (for married taxpayers filing separately), or $33,750 (for single taxpayers and heads of households), subject to certain phaseout provisions. If AMT is paid in one year, an AMT credit (the minimum tax credit -- MTC) may be available to reduce the taxpayer’s regular income tax liability in later years.

Given the narrow gap between the AMT rates of 26% and 28% and the regular tax rates (28% on capital gains and 31%, 36%, and 39.6% on ordinary income), payment of the AMT can easily be triggered. In fact, the state income taxes caused by large capital gains can trigger AMT all by themselves. Thus, it is important in your tax planning activities to address the AMT as well as the regular tax.

Remember that these tax preferences are always added back to regular taxable income in computing alternative minimum taxable income.

If you use the standard deduction in calculating your regular taxable income, your standard deduction is added back to regular taxable income, along with the deduction for personal exemptions, in determining your AMT. If you take itemized deductions, the following deductions are added back for AMT purposes:

The 3% reduction of itemized deductions based on adjusted gross income in excess of $117,950 ($58,975 for married filing separately) for 1996 that applies for regular tax purposes does not apply in calculating the AMT. Thus, you get the full benefit of those deductions in computing your AMTI.

These adjustments may be positive or negative, depending on how an item is treated in the current year as well as how it was treated in earlier years. For example, an increase or positive adjustment for excess depreciation on property placed in service after 1986 will result in different tax bases for regular tax and AMT purposes. Thus, when the property is sold, a subtraction from regular taxable income will be necessary to avoid subjecting a portion of the gain to double taxation. The recordkeeping for each asset for regular tax and AMT, and potentially another set of computations for state regular tax and AMT, requires you to understand these rules and to apply them systematically.

The AMT exemption ($45,000 for married taxpayers filing jointly, $33,750 for single taxpayers, and $22,500 for married taxpayers filing separately) is phased out for higher-income taxpayers. This exemption is reduced by $1 for every $4 by which AMTI exceeds an AMTI threshold ($150,000 for married taxpayers filing jointly, $112,500 for single taxpayers, and $75,000 for married taxpayers filing separately). Taxpayers with AMTI in the phaseout range will encounter yet another "hidden" tax rate on marginal income (see the table below).

Marginal AMTI Rates for Married Taxpayers Filing Jointly
Alternative Minimum Taxable Income (Before AMT Exemption)	Marginal Tax Rate
Below $150,000	26%
$150,000 to $206,000	32.5%
$206,000 to $330,000	35%
Over $330,000	28%

To better understand the effect of the AMT on tax planning, consider the following example of a married couple with two children filing a joint return:

Alternative Minimum Tax Example: Capital Gains
Facts:
Income
Salaries	$120,000
Capital gains (long-term)	$100,000
Interest on tax-exempt private activity bonds	$20,000
Incentive stock option bargain element	$15,000
Deductions
State and local taxes	$22,000
Charitable contributions	$25,000
Home mortgage interest	$20,000
Miscellaneous deductions (in excess of 2% of AGI)	$2,000

Comparing Regular Tax and AMT
	Regular Tax	AMT
Income
Salaries	$120,000	$120,000
Capital gain	$100,000	100,000
Adjustment:
Incentive stock option	--	15,000
Preference item:
Private activity bond interest	--	$20,000
Total income	$220,000	$255,000

Itemized Deductions
State and local taxes	- 22,000	--
Charitable contributions	- 25,000	- 25,000
Home mortgage interest	- 20,000	- 20,000
Miscellaneous	- 2,000	--
Less 3% of AGI in excess of $117,950	$3,062	--
Allowed itemized deductions	- 65,938	- 45,000
Taxable income before personal exemptions	$154,062	$210,000
Personal exemptions
(4 x $2,550 -- partially phased out)	- 6,528
Regular taxable income	$147,534
AMT exemption (partially phased out)		- 30,000
Alternative minimum taxable income		$180,000
Regular tax	$36,097
Tax with AMT		$46,900
Total tax paid	$46,900

The taxpayers have a 35% marginal AMT rate, even though the nominal maximum tax rate on capital gains is 28%. To avoid this, they would have to:

The best time for this planning to occur is before the capital gain is realized so that it can be timed to minimize its overall tax effect.

An important feature of the AMT system is the minimum tax credit. To the extent that you pay AMT because of deferral preferences, as compared to exclusion preferences, you may be able to reduce your regular income tax in a future year through the use of the MTC. Exclusion preferences are tax-exempt interest on private activity bonds issued after Aug. 7, 1986, itemized deductions not allowed for AMT (such as state and local taxes), the standard deduction, and personal exemptions. All other AMT adjustments and preferences are deferral preferences. If you pay AMT that is attributable to deferral preferences, you will be able to carry over the MTC to future tax years indefinitely. However, the amount of the MTC that can be used each year is limited to the excess of the regular tax over the AMT in that year.

You must consider acceleration and deferral of income and deductions when the AMT may apply, just as when the regular tax applies. For instance, if you anticipate that the AMT will apply to your income for 1996, you may consider accelerating ordinary income into 1996 to take advantage of the 26% or 28% rate. This technique is most appropriate when the AMT is attributable to exclusion preferences. In addition, you should consider acceleration when your projection of your tax circumstances suggests that the MTC generated by deferral preferences cannot be expected to be used within the next several years. You should also consider the time value of money in any decision to accelerate large amounts of income, because the acceleration will result in the payment of taxes sooner than might otherwise be required.

You need to plan carefully in situations in which you have large long-term capital gains to avoid tax rates in excess of 28% at income levels that require the phaseout of the AMT exemption. In addition, if you have a substantial capital gain, you may actually lose the benefit of the state and local tax deduction in its entirety. The payment of state income taxes needs to be carefully planned to maximize the federal tax benefit you realize.

You should take special care in evaluating investments (such as private activity bonds) and exercising incentive stock options to avoid unnecessary payment of the AMT. Analyze your tax situation early in the year to know whether the AMT will apply and how to minimize its effect.

Because of the narrow range of the tax brackets for regular tax, capital gains tax, and alternative minimum tax, if you have potential AMT problems, you should consider planning in advance and taking into consideration the possible application of the AMT over several years. Because these provisions are complicated, you should consult your tax adviser when developing your plans. Analyzing your AMT situation early in the year can help you minimize tax.

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