The AMT is a modified "flat-rate" tax that coexists within the regular income tax system. You
should care because it might cost you big bucks in Federal income taxes.
The tax law gives special treatment to certain kinds of income and allows
special deductions for certain kinds of expenses. The AMT was designed to
increase the tax bill of taxpayers who take undue advantage of these tax
benefits to avoid significant tax liability. The basic mechanism by which the
AMT accomplishes its objective is by treating certain items less favorably
than they are for purposes of the regular tax. These items are referred to as
“tax preferences” or “adjustments.” Adjustments differ from
preferences only in that adjustments involve a substitution of a special AMT
treatment of an item for the regular tax treatment (for example, no deduction
is allowed for personal and dependency exemptions), while a preference
generally involves the addition of the difference between the special AMT
treatment and the regular tax treatment (for example, depletion is limited to
the adjusted basis of the property).
The AMT starts with your regular taxable income and, in general, makes you
“give back” the tax preferences and adjustments until you arrive at
“alternative minimum taxable income” (AMTI). Then, after subtracting an
exemption amount (discussed below), a tax rate of 26% applies to the first
$175,000 of this income and 28% to amounts above $175,000. (For married
taxpayers who file separately, the rate changes at $87,500.) However, the AMT
rates for long-term capital gains, as well as “qualified dividend income”
eligible to be taxed at long-term capital gain rates, are the same favorable
rates that apply for regular tax purposes. If the tax liability under the AMT
system is higher than your regular tax liability, you must pay the higher
amount. If the AMT liability comes out below your regular liability, then the
AMT has no tax impact on you and you simply pay your regular tax liability.
You may be subjected to the AMT even if you have no tax preferences. You
will have to compute the AMT with the adjustments. Thus, if you have a large
family, elimination of the personal and dependency exemptions to which you are
entitled for regular tax purposes may cause you to be subject to the AMT. You
compute the AMT on a special IRS form (Form 6251) which must be attached to
your Form 1040.
Adjustments and preferences. The following are some of the
more common adjustments or preferences required to arrive at AMTI:
(1) Tax-exempt interest. Tax-exempt interest from certain private
activity bonds isn't exempt for AMT purposes. Thus, although you exclude this
interest from your regular taxable income, you must include it for AMTI.
(2) Interest deduction. For AMT purposes you can only deduct
mortgage or home equity loan interest on funds you borrowed to buy, build, or
substantially improve your home or a second residence (or on the refinancing
of that debt). So, if you claimed a regular tax deduction for interest on a
home equity loan that you didn't devote to the home, you would have to add it
back in determining AMTI. Also, an adjustment may have to be made to your
investment interest deduction in some cases for AMT purposes.
(3) State and local tax deduction. For AMT purposes, you get no
deduction for state and local income taxes or real estate or other property
taxes.
(4) Medical expenses. If you are deducting any medical expense for
regular tax purposes, some of the deduction will be lost for AMT purposes. For
regular tax purposes, medical expenses are deductible to the extent they
exceed 7.5% of adjusted gross income (AGI). For AMT purposes, however, they
are only deductible to the extent they exceed 10% of AGI. Thus, you
would compute your reduced deduction amount and add the difference back to
taxable income in determining AMTI. (For example, if your “regular”
medical deduction was $8,000 and your AMT medical deduction is $6,000, you
would add back $2,000 to taxable income.)
(5) Miscellaneous itemized deductions. If you are entitled to a
regular tax deduction for any miscellaneous itemized expenses (these are
deductions that are limited, even for regular tax purposes, to the excess over
2% of your AGI), you would not get any deduction for them for AMT
purposes, regardless of what they are comprised of.
(6) Personal and dependency exemptions. These aren't allowed. You
must add them back to your regular taxable income in determining AMTI.
(7) Standard deduction. If you take the standard deduction instead
of itemizing, you must add back the deduction to determine AMTI.
(8) Incentive stock options (ISOs). The favorable tax treatment
allowed for incentive stock options isn't allowed for AMT purposes. This means
that although you don't pay any regular tax when you exercise an ISO, you may
have to pay alternative minimum tax on the value of the stock you receive
(minus what you paid for it) in the year you exercise the ISO. This is true
even if you don't sell the stock and even if the stock price declines
significantly after you exercise the ISO.
(9) Depreciation deductions. For certain depreciable property you
are placed on slower depreciation schedules for AMT purposes. Therefore, some
adjustments may have to be made in your depreciation deductions and gain or
loss on the sale of this property.
(10) Depletion. For AMT purposes, depletion is allowed only to the
extent of your adjusted basis for the property.
(11) Other preferences. Other types of preferences may apply
depending on your particular tax situation. Please call if you would like me
to review your overall tax situation from the AMT perspective.
Exemption amounts. As noted above, in computing your AMT,
after you arrive at AMTI, you subtract your exemption. For single taxpayers,
the exemption amount is $40,250 ($33,750 after 2004). However, you must reduce
the exemption by 25% of the amount by which AMTI exceeds $112,500. For married
taxpayers filing jointly and surviving spouses, the exemption is $58,000
($45,000 after 2004) and the 25% reduction starts when AMTI exceeds $150,000.
For married taxpayers filing separately, the exemption amount is $29,000
($22,500 after 2004) and the 25% reduction starts when AMTI exceeds $75,000
(and you may have to include an additional amount in AMTI).
A nonrecurring spike of income—for example, the recognition of a
significant amount of capital gains in a year—might trigger the phaseout
(under the 25% reduction rules discussed above) of your AMT exemption, which
could result in an AMT liability. This could happen even though, as mentioned
above, the AMT rates on long-term capital gains and qualified dividend income
are the same favorable rates that apply for regular tax purposes. The
inclusion of long-term capital gains in your taxable income, as well as in
your AMTI, might also affect your entitlement to various deductions and
credits, and the amounts of AMT preferences and adjustments, that vary or
phase out depending on the amount of your income.
AMT credit. Once you are subject to the alternative
minimum tax, you may be entitled to a credit which can reduce your tax
liability in the future. Please let us know if you would like additional
information about this AMT credit.
