CHAPTER 14 ALTERNATIVE MINIMUM TAX SOLUTIONS TO …isu.indstate.edu/acharmo/smpdf/CH14.pdf ·...

CHAPTER 14

ALTERNATIVE MINIMUM TAX

SOLUTIONS TO PROBLEMS MATERIALS

Status: Q/P Question/ Present in Prior Problem Topic Edition Edition

1 AMT purpose Unchanged 12 AMTI: direct versus indirect calculation approach Unchanged 23 AMT adjustments Unchanged 34 Tax preferences Modified 45 Tax preferences Unchanged 56 AMT formula Unchanged 67 Regular income tax liability versus AMT Unchanged 78 AMT exemption amount Unchanged 89 AMT rates Unchanged 9

10 AMT and nonrefundable tax credits Unchanged 1011 AMT adjustment for cost recovery on realty Unchanged 1112 AMT adjustment for mining exploration and

development costs Unchanged 12

13 Issue ID Unchanged 1314 Long-term contract income adjustment New 15 Incentive stock options adjustment New 16 Regular income tax adjusted basis versus AMT

adjusted basis Unchanged 16

17 Issue ID Modified 1718 Passive activity losses AMT adjustment Unchanged 1819 ATNOLD Unchanged 1920 AMT and itemized deductions Unchanged 2021 Issue ID Unchanged 2122 AMT cutback adjustment Unchanged 2223 AMT and interest Unchanged 2324 AMT and personal and dependency exemptions Unchanged 2425 Percentage depletion preference New 26 Private activity bond preference Unchanged 26

14-1

14-2 2004 Comprehensive Volume/Solutions Manual

Status: Q/P Question/ Present in Prior Problem Topic Edition Edition

27 Purpose of AMT credit Unchanged 2728 Corporate versus noncorporate AMT New 29 Effect of ACE adjustment on financial and tax

accounting Unchanged 29

30 AMT planning on recognition of income Unchanged 30* 31 AMT base Unchanged 31* 32 AMT calculation Unchanged 32* 33 AMT calculation Unchanged 33* 34 AMT exemption amount Modified 34* 35 AMT and nonrefundable credits Unchanged 35

36 AMT adjustments: circulation expenditures Modified 36* 37 Adjustments for circulation expenditures Unchanged 37

38 Cost recovery adjustment for AMT: realty Modified 3839 Cost recovery adjustment for AMT: personalty Unchanged 3940 Mining and exploration costs adjustment Unchanged 40

* 41 AMT adjustment for long-term contract New * 42 Incentive stock option adjustment Unchanged 42

43 Adjustments for incentive stock options New * 44 AMT adjustments: adjusted gain or loss Unchanged 44

45 Computing AMT passive loss Unchanged 4546 Itemized deductions adjustment for AMT and

medical expenses Modified 46

* 47 AMT adjustments for itemized deductions Unchanged 47* 48 Mortgage interest adjustment for AMT Unchanged 48

49 Adjustment for investment interest and private activity bond preference

Unchanged 49

* 50 Itemized deductions adjustment for AMT New 51 AMT standard deduction and personal exemption

adjustments New

52 AMT percentage depletion preference New * 53 AMT IDC preference Unchanged 53

54 Tax preference items and AMT adjustments including private activity bonds

Unchanged 54

* 55 Comprehensive AMT calculation New * 56 AMT calculation Unchanged 56* 57 Computation of taxable income and AMT Unchanged 57* 58 Computation of taxable income and AMT New * 59 AMT tax credit carryover Unchanged 59* 60 Exemption from corporate AMT for small

corporations Modified 60

* 61 ACE adjustment Unchanged 61* 62 Corporate AMT Unchanged 62* 63 Corporate AMT Unchanged 63* 64 Cumulative Modified 64* 65 Cumulative Modified 65 *The solution to this problem is available on a transparency master.

Alternative Minimum Tax 14-3

CHECK FIGURES 31. $204,875. 32.a. $27,137. 32.b. $57,365. 33. Case 1: MFJ $26,699; single

$21,177. Case 2: MFJ $11,699; single $6,177. 34. Case 1: Single $30,125; MFJ

$49,000; MFS $9,500. Case 2: Single $5,125; MFJ

$27,750; MFS $0. Case 3: Single $0; MFJ $0; MFS $0. 35.a. $0. 35.b. $78,000. 36. Expensing saves $31,128;

amortizing saves $36,080. 37. 2003 positive $90,000; 2004

negative $5,000. 38.a. $3,862 positive adjustment. 38.b. $0. 39.a. $12,500 positive. 39.b. Elect 150% DB method. 40.a. $540,000 positive adjustment for

2003. 40.b. Amortize expenditures over 10

years. 41. $120,000 positive adjustment for

2003; $120,000 negative adjustment for 2004.

42.a. No reporting required in 2003. 42.b. No reporting required in 2007. 42.c. Positive adjustment of $30,000 for

AMT in 2008. 42.d. Regular income tax recognized gain

of $80,000; AMT recognized gain of $50,000.

43. $27,000 positive AMT adjustment in 2003; $27,000 negative AMT adjustment in 2004.

44.a. Regular income tax recognized gain of $350,000 on the building and $150,000 on the land; AMT recognized gain of $310,000 on the building and $150,000 on the land.

44.b. $40,000 negative adjustment on the building and $0 on the land.

45. No deduction; $11,750 suspended regular tax; $3,000 suspended AMT.

46.a. $14,500. 46.b. $9,500. 46.c. $5,000 positive. 47.a. $14,500. 47.b. $8,500 positive. 48. $5,000 positive. 49. Regular income tax $10,000; AMT

$11,500. 50.a. $17,450 positive. 50.b. $17,450 positive and $1,100 tax

preference. 51. $207,800. 52. $9,000 tax preference. 53. $24,000. 54. $51,800. 55. $76,650 taxable income; $25,350

tentative AMT. 56. $17,663. 57.a. $117,800. 57.b. $31,667. 58. Total tax is $34,427. 59. $63,795. 60.a. Exempt initially from AMT as a

“small corporation” in 1998. 60.b. No. 61. 2002 $750 positive; 2003 $750

positive; 2004 $1,500 negative. 62. Quincy $22,000; Redland $24,500;

Tanzen $64,000. 63.a. $1,020,000. 63.b. AMTI $3,690,000; tentative AMT

$738,000. 63.c. AMT $0. 64. $3,349 regular tax liability plus

$20,084 AMT. 65. $43,352 regular tax liability plus

$9,648 AMT.


DISCUSSION QUESTIONS 1. Through the use of exclusions, deductions, and credits, the regular income tax liability

can be reduced or eliminated. Congress felt that some taxpayers with substantial economic incomes were taking undue advantage of these tax reduction opportunities and thereby were concerned about the inequality that resulted. Therefore, the AMT was enacted. p. 14-2

2. Starting with taxable income in calculating the AMT is the indirect approach. This is the

approach normally used and the one followed in Form 6251. However, the AMT also can be calculated using the direct approach.

Gross income computed by applying the AMT rules Minus: Deductions computed by applying the AMT rules Equals: AMTI before tax preferences Plus: Tax preferences Equals: AMT income Minus: Exemption Equals: AMT base Times: Rates Equals: Tentative AMT before foreign tax credit Minus: AMT foreign tax credit Equals: Tentative AMT Minus: Regular income tax liability before credits other than the foreign tax credit Equals: AMT

Note that both approaches produce the same amount of AMT. pp. 14-4, 14-5, and

Figure 14-1 3. The statement is correct for AMT adjustments that relate to timing differences (e.g.,

circulation expenditures and depreciation). However, not all AMT adjustments relate to timing differences (e.g., itemized deductions permitted for regular income tax purposes that are not permitted for AMT purposes). These adjustments do not reverse. pp. 14-4 to 14-6

4. a., d., and e. are tax preferences for the AMT. p. 14-6 5. d. and e. are tax-preferences for the AMT. a. and b. are neither an AMT adjustment nor a

tax preference. c. is an AMT adjustment. pp. 14-4 to 14-6 6. The AMT tax formula is as follows:

Regular taxable income Plus or minus: Adjustments Equals: Taxable income after AMT adjustments Plus: Tax preferences Equals: Alternative minimum taxable income Minus: AMT exemption Equals: Alternative minimum tax base Times: 26% or 28% rate Equals: Tentative AMT before foreign tax credit Minus: Alternative minimum tax foreign tax credit Equals: Tentative minimum tax


Minus: Regular tax liability* Equals: Alternative minimum tax (if amount is positive) *Regular tax liability for the year reduced by any allowable foreign tax credit. Figure 14-2

7. The statement is incorrect. There is an AMT liability only if the tentative AMT exceeds

the regular income tax liability. The amount of the excess is the AMT. The total tax liability is the summation of the regular income tax liability and the AMT. pp. 14-9 and 14-10

8. a. The AMT exemption can be thought of as a materiality amount. It relieves taxpayers who do not have substantial adjustments and preferences from the burden of the AMT.

b. The initial amount (prior to the phaseout) of the exemption is as follows:

•

•

•

$35,750 for a single taxpayer.

$49,000 for married taxpayers filing jointly.

$24,500 for married taxpayers filing separately. c. The phaseout of the exemption amount is an application of the wherewithal to pay

concept. As the ability to pay increases as measured by the taxpayer’s AMTI, the justification for relieving the taxpayer of the burden of the AMT decreases.

pp. 14-8 and 14-9

9. In calculating the tentative AMT, the AMT base normally is multiplied by the AMT statutory rates of 26% (on the first $175,000 of the AMT base) or 28% (on the AMT base in excess of $175,000). However, Alice’s net capital gain of $100,000 that is included in the AMT base is eligible for the same alternative tax rate (i.e., 20% for Alice) that is used in the regular tax liability calculation. p. 14-9

10. Historically the answer was no. Only the foreign tax credit could reduce the regular

income tax liability below the amount of the tentative AMT. However, now certain nonrefundable personal credits (e.g., child tax credit, adoption expenses credit, credit for elective deferrals and IRA contributions) are permitted to offset both the regular income tax liability and the AMT. p. 14-10

11. Andy’s conclusion is wrong. The AMT cost recovery for a warehouse placed in service

in 1997 is computed under the alternative depreciation system (ADS), which uses the straight-line method over a 40-year life. The regular income tax cost recovery is computed under the straight-line method over a 39-year life. Thus, the difference between the AMT cost recovery and regular income tax cost recovery on Andy’s warehouse is treated as an adjustment in computing the AMT. Note, however, that for real property placed in service after December 31, 1998, the regular income tax cost recovery period of 39 years (or 27.5 years for residential property) is to be used in calculating the AMT cost recovery. Thus, for such property, there will be no AMT adjustment for cost recovery. pp. 14-11 and 14-12


12. For regular income tax purposes, mining exploration and development costs may be expensed in the year incurred. For AMT purposes, such costs must be amortized over 10 years. The AMT adjustment for mining exploration and development costs is equal to the amount expensed minus the amount that would have been allowed if the costs had been capitalized and amortized ratably over a 10-year period. The AMT adjustment can be avoided if the taxpayer elects to write off the costs over a 10-year period for regular income tax purposes. pp. 14-13 and 14-14

13. Rick may be misinformed regarding the AMT. Merely because the AMT exemption

amount is zero and there are adjustments or tax preferences present does not automatically mean an AMT will result. What Rick needs to do is to determine if an AMT (and the amount) would result if he expenses the mining exploration and development costs for regular income tax purposes. pp. 14-7 and 14-13

14. For a long-term contract, taxpayers are required to use the percentage of completion

method for AMT purposes. If a taxpayer uses the completed contract method for regular income tax purposes, this will give rise to an AMT adjustment equal to the difference between income reported under the percentage of completion method and the amount reported using the completed contract method. The adjustment can be either positive or negative depending on the amount of income recognized under the different methods. p. 14-14

15. a. If Megan exercises the incentive stock option (ISO), she will have an AMT

adjustment of $4,500 [($65 fair market value – $20 option price) X 100 shares] in the first taxable year in which the rights in the stock are freely transferable or are not subject to a substantial risk of forfeiture. She will not be required to recognize any income for regular income tax purposes as a result of exercising the ISOs. For AMT purposes, the basis of such stock is equal to the fair market value taken into account in determining the adjustment. Examples 10 and 11 and related discussion

b. Yes. If Megan exercises the option and disposes of the stock in the same tax year,

there is no AMT adjustment. p. 14-14 16. The regular income tax adjusted basis for the building is determined by subtracting the

regular income tax depreciation deductions. The AMT adjusted basis for the building is determined by subtracting the AMT depreciation deductions. Since the regular income tax and the AMT depreciation deductions are not the same for a building placed in service before January 1, 1999, the adjusted basis for regular income tax and AMT purposes will differ. Consequently, the recognized gain or loss for regular income tax and AMT purposes will also differ. pp. 14-15 and 14-16

17. The relevant issues are the tax consequences of each of the two proposed transactions for

both regular income tax purposes and for AMT purposes. The AMT analysis is relevant only if the AMT applies since the adjustment would be negative. For regular income tax purposes, the sale to Abby in 2004 would result in deferring the reporting of the gain of $20,000 until 2004. This deferral treatment also would apply for AMT purposes (i.e., the realized loss of $5,000 cannot be recognized). If the sale occurred in 2003 to Ed, for regular income tax purposes, the $20,000 realized gain is recognized. However, for AMT purposes, there would be a $25,000 negative adjustment for the difference between the $20,000 gain for regular income tax purposes and the $5,000 loss for AMT purposes. Note also that for regular income tax purposes, any portion of the $20,000 recognized


gain that is classified as ordinary income will be subject to a higher tax rate in 2003 (27%) than in 2004 (26%). pp. 14-15 and 14-16

18. Income or loss from passive activities is computed differently for regular income tax

purposes and for AMT purposes. For example, the depreciation and depletion rules differ for regular income tax and AMT purposes. The resulting difference in net income (loss) could require an AMT adjustment. pp. 14-16, 14-17, and Example 15

19. Positive adjustments and tax preferences are added to the regular income tax NOL in

calculating the ATNOLD (i.e., making the ATNOLD a smaller amount). Negative adjustments are subtracted from the regular income tax NOL in calculating the ATNOLD. pp. 14-17 and 14-18

20. The tax treatment for regular income tax and AMT purposes is the same for the

following: Casualty losses Charitable contributions

A deduction for state income taxes, miscellaneous itemized deductions subject to the 2% floor, and real estate taxes is not permitted for AMT purposes. While a deduction is permitted for medical expenses for AMT purposes, the floor is 10% of AGI rather than the 7.5% floor.

pp. 14-18 to 14-20 21. The obvious issue is whether Matt should follow the friend’s advice in order to increase

his itemized deductions. On the surface, this appears to be sound tax advice. Factoring in the effect of indexing on the standard deduction, it appears that Matt may have to use it in the future. Incurring the mortgage on the beach house would enable him to continue to itemize deductions. However, another issue that needs to be addressed is whether Matt will be subject to the AMT. The mortgage interest on the beach house will be deductible for AMT purposes, since it is qualified housing interest. In addition, determination needs to be made of whether the tax-exempt bonds in which Matt is investing are private activity bonds, since the interest on such bonds is a tax preference. pp. 14-20 and 14-23

22. The purpose of the cutback adjustment for regular income tax purposes is to partially

phase out the deduction for itemized deductions for high income taxpayers (i.e., AGI exceeds a threshold amount). The AMT calculation takes a different approach by disallowing certain itemized deductions (e.g., state income taxes, property taxes) and by reducing the amount of others (e.g., medical expenses, qualified housing interest versus qualified residence interest). There is no cutback adjustment in calculating the AMT. Since the starting point for calculating the AMT is taxable income, there is a negative adjustment for the amount of the cutback adjustment in calculating AMTI. p. 14-19

23. The interest deduction for regular income tax purposes includes qualified residence

interest, investment interest to the extent of net investment income reported in computing taxable income, and qualified interest on student loans (i.e., a deduction for AGI). The alternative minimum tax itemized deduction for interest includes qualified housing interest, plus other interest to the extent of qualified net investment income that is included in the AMT base, and qualified interest on student loans. Qualified housing interest could be less than qualified residence interest. pp. 14-19 to 14-21


24. For regular income tax purposes, a deduction of $3,050 in 2003 is permitted for each personal exemption and dependency deduction (subject to partial phaseout as AGI exceeds a threshold amount). For AMT purposes, the benefit of this deduction is eliminated with a positive adjustment in calculating AMTI. However, in converting AMTI to the AMT base, an AMT exemption is allowed ranging from $24,500 to $49,000 (subject to complete phaseout as AMTI exceeds a threshold amount). If there were not a positive adjustment for the personal and dependency exemptions amount deducted in calculating taxable income, the taxpayer would receive double benefits in calculating the AMT. pp. 14-8, 14-9, and 14-21

25. A tax preference is created for AMT purposes once the adjusted basis of the mineral

deposit is reduced to $0 and percentage depletion continues to be deducted. p. 14-22 26. For regular income tax purposes, the $18,000 of interest income is excludible from gross

income and the $7,000 of interest expense is not deductible. For AMT purposes, interest earned on private activity bonds is included in AMTI. Interest incurred in purchasing or carrying such bonds is offset against the interest income. Also, for AMT purposes, the interest earned (net of any related expenses) on private activity bonds is included in the calculation of net investment income in calculating the investment interest deduction. pp. 14-21 and 14-23

27. The purpose of the AMT credit is to provide equity for the taxpayer when timing

differences that give rise to AMT adjustments reverse. The credit arises when positive adjustments are included in the AMT base. It is used to reduce the regular income tax liability for prior years’ AMT liability attributable to timing differences.

To determine the amount of the AMT credit, it is necessary to compute the AMT with timing adjustments and AMT exclusions (non-timing adjustments and preferences) included in the AMT base. The AMT credit carryover is the difference between the amount so computed and the AMT that would result without including timing adjustments in the AMT base. The AMT credit may be carried over indefinitely. Examples 29 to 31 and related discussion

28. The AMT applicable to corporations is similar to that applicable to noncorporate

taxpayers. However, there are several important differences:

• The corporate AMT rate is 20% versus 26% and 28% for noncorporate taxpayers.

• The AMT exemption for corporations is $40,000 reduced by 25% of the amount by which AMTI exceeds $150,000.

• Tax preferences applicable to noncorporate taxpayers are also applicable to corporate taxpayers, but some adjustments differ including the ACE adjustment.

• A small corporation is exempt from the AMT. In addition, all corporations are exempt from the AMT in the first year of existence.

pp. 14-27 to 14-33 29. Through the ACE adjustment, Congress is indirectly imposing a conformity requirement

on corporations. While a corporation may still choose to use different methods for tax and financial accounting purposes, it may no longer be able to do so without the possibility of incurring AMT as a result of the ACE adjustment. Thus, a corporation may incur AMT not only because of specifically targeted adjustments and preferences, but


also as a result of any methods that cause adjusted current earnings to exceed AMTI before the ACE adjustment. pp. 14-30 to 14-32

30. Situations can arise when it would be advisable for a taxpayer to accelerate income into

an AMT year. A 27% to 38.6% taxpayer who is subject to the AMT in the current year should consider accelerating income into the AMT year so the income will be taxed at a 26% or 28% rate. For example, collectibles that produce long-term capital gain can be sold in the AMT year, exposing the gain to a possible 26% rate, rather than the 28% alternative capital gains rate that might otherwise apply. Examples 36 and 37 and related discussion

PROBLEMS 31. Rachel’s taxable income $175,000 Plus: Positive AMT adjustments 95,000 Tax preferences 25,000 Less: Negative AMT adjustments (80,000) Equals: AMTI $215,000 Less: Exemption [$35,750 – 25%($215,000 – $112,500)] (10,125) Equals: AMT base $204,875 pp. 14-4 to 14-9 32. a. Calculation of regular income tax liability: Tax on $120,000: $ 14,868 On $68,800 15,360 On $51,200 X 30% $ 30,228 Calculation of AMT: Taxable income $120,000 Adjustments 60,000 Tax preferences 45,000 AMTI $225,000 Exemption [$35,750 – 25%($225,000 – $112,500)] (7,625) AMT base $217,375 Rate: 26% X $175,000 $45,500 28% X $ 42,375 11,865 Tentative AMT $ 57,365 Regular income tax liability (30,228) AMT $ 27,137 b. Arthur’s total tax liability is $57,365, the summation of the regular tax liability of

$30,228 and the AMT of $27,137.


c. Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040

February 6, 2004

Mr. Arthur East 100 Colonel’s Way Conway, SC 29526 Dear Mr. East:

As you requested, we have calculated your Federal tax liability for 2003. The

total amount is $57,365. This consists of the regular income tax liability of $30,228 and the alternative minimum tax (AMT) liability of $27,137. The calculation of the regular income tax liability appears on Form 1040.

Since this is the first year that you have been subject to the AMT, I thought that I should comment on this additional tax. The calculation of the AMT appears on Form 6251. The AMT is a parallel income tax system. Its purpose is to provide assurance that no taxpayer with substantial economic income can avoid significant tax liability by using exclusions, deductions, and credits. As indicated on Form 6251, some of the exclusions and deductions on your Form 1040 are disallowed on your Form 6251. Such items are treated as positive adjustments and preferences on Form 6251.

I would like to work with you to minimize your AMT in the future. Since this is

our first year to do tax compliance work for you, we think we can use tax planning techniques to reduce your Federal tax liability. Please call me so we can schedule a meeting at a time convenient to you. Sincerely, Steve Ash, CPA Partner

pp. 14-7 to 14-9 and Figure 14-2

33. Case 1 Married filing jointly Single Tentative AMT $190,000 $190,000 – Regular tax liability (163,301)** (168,823)* = AMT $ 26,699 $ 21,177 * $96,236 + $72,587 = $168,823. ** $90,714 + $72,587 = $163,301.


Case 2 Married filing jointly Single Tentative AMT $175,000 $175,000 – Regular tax liability (163,301)** (168,823)* = AMT $ 11,699 $ 6,177 Figure 14-2 34. Single taxpayer:

Case 1 $35,750 – 25%($135,000 – $112,500) = $30,125 Case 2 $35,750 – 25%($235,000 – $112,500) = $ 5,125 Case 3 $35,750 – 25%($435,000 – $112,500) = $ -0- Married filing jointly: Case 1 $49,000 – $0(no exemption phase out) = $49,000 Case 2 $49,000 – 25%($235,000 – $150,000) = $27,750 Case 3 $49,000 – 25%($435,000 – $150,000) = $ -0- Married filing separately: Case 1 $24,500 – 25%($135,000 – $75,000) = $9,500 Case 2 $24,500 – 25%($235,000 – $75,000) = $ -0- Case 3 $24,500 – 25%($435,000 – $75,000) = $ -0- pp. 14-8 and 14-9

35. a. Leona’s AMT is $0. Tentative AMT $ 78,000 Regular income tax liability (135,000) Excess of tentative AMT over regular tax liability ($ 57,000) Since the result is negative, Leona has no AMT. b. The nonrefundable credits cannot reduce the regular income tax liability below

the amount of the tentative AMT. Therefore, Leona can use only $57,000 of the $65,000 nonrefundable credits to reduce her regular income tax liability to $78,000 ($135,000 – $57,000). The remaining $8,000 ($65,000 – $57,000) of nonrefundable credits will be lost unless they are the type of credits which qualify for carryback and/or carryforward.

pp. 14-9, 14-10, and Figure 14-2 36. Angela has two options available for the $123,000 of circulation expenditures. First, she

could deduct the entire $123,000 in 2003. If she does this, she will have a positive AMT adjustment of $82,000 ($123,000 – $41,000) in 2003 and negative AMT adjustments of $41,000 ($0 – $41,000) in 2004 and 2005. Under the second option, Angela could elect to capitalize the circulation expenses and deduct them over a 3-year period (i.e., $41,000 per year). If this election is made, there is no AMT adjustment, since the deduction will be the same for regular income tax purposes and AMT purposes.


The 30% bracket for single taxpayers begins at $68,800 and ends at $143,500 in 2003. The first $6,000 is taxed at 10%, the next $22,400 is taxed at 15%, and the next $40,400 is taxed at 27%. If Angela deducts the entire $123,000 in 2003, she will have zero taxable income. As a result, she will have used $6,000 of the $123,000 deduction to offset income that would be taxed at 10%, $22,400 of the $123,000 deduction to offset income that would be taxed at a 15% rate, $40,400 to offset income that would be taxed at the 27% rate, and $54,200 to offset income that would be taxed at 30%. Her maximum potential savings from this strategy will be $14,868 (the tax on $68,800) plus 30% on the remainder of $54,200 ($123,000 – $68,800). Thus, the tax effect of the $123,000 deduction would be $31,128 [$14,868 + .30($54,200)]. The 30% bracket spans more than $41,000 in 2003 ($143,500 – $68,800 = $74,700), and the 29% bracket is likely to span a similar range in 2004 and 2005. If Angela writes off the circulation expenditures over three years at the rate of $41,000 per year, the entire $123,000 deduction will offset income that would be taxed at near 30% (i.e., 30% in 2003 and 29% in 2004 and 2005). Therefore, Angela should be advised that she can achieve substantial tax savings by amortizing the circulation expenditures over a three-year period. Her tax savings from a $123,000 deduction spread over 3 years at 30% in 2003 and 29% in 2004 and 2005 would be $36,080 [($41,000 X 30%) + ($41,000 X 29%) + ($41,000 X 29%)].

In summary, Angela could save $31,128 in income tax if she expenses the circulation expenditures in the year incurred, but could save $36,080 if she amortizes them over 3 years.

Note: The time value of money should be considered in computing the final tax savings

achieved by the three-year amortization strategy. p. 14-11

37. Computation of adjustment for circulation expenditures: 2003 regular income tax deduction $135,000 2003 AMT deduction ($135,000/3) (45,000) Positive AMT adjustment in 2003 $ 90,000 2004 regular income tax deduction $ 60,000 2004 AMT deduction: [($135,000/3) + ($60,000/3)] (65,000) Negative AMT adjustment in 2004 ($ 5,000) p. 14-11 38. a. If the apartment building is acquired and placed in service in 1997, there is an

AMT positive adjustment for 2003 because the regular income tax cost recovery period is 27.5 years and the AMT cost recovery period is 40 years.

Regular income tax cost recovery for 2003 (Table 7-9): $340,000 X 3.636% = $12,362 AMT cost recovery for 2003 (Table 7-10): $340,000 X 2.500% = $8,500


Thus, the amount of the positive AMT adjustment is $3,862 ($12,362 – $8,500). b. If the apartment building is acquired and placed in service in 2003, there is no

AMT adjustment for cost recovery for 2003 because the regular income tax cost recovery period of 27.5 years also is used for AMT purposes.

Regular income tax cost recovery for 2003 (Table 7-9): $340,000 X 3.485% = $11,849 AMT cost recovery for 2003 (Table 7-9): $340,000 X 3.485% = $11,849 pp. 14-11 and 14-12 39. a. In order to produce the largest depreciation deduction for regular income tax

purposes, Helen will use Table 7-1 (200% DB method). For AMT purposes, she must use Table 7-4 (150% DB method).

Regular income tax depreciation ($250,000 X 20%) $50,000 AMT depreciation ($250,000 X 15%) (37,500) Positive adjustment $12,500

b. Helen could elect to depreciate the equipment using Table 7-4 (150% DB method) for regular income tax purposes rather than under the regular MACRS method (200% DB method). The election reduces the depreciation percentage factor from 20% to 15%. Therefore, the depreciation deduction for both AMT purposes and regular income tax purposes would be $37,500.

Making the election reduces the AMT adjustment to $0. Such an election may be

beneficial if Helen is going to be subject to the AMT. The election would not be beneficial if Helen’s regular tax liability is going to exceed her tentative AMT anyway.

c. Willis, Hoffman, Maloney, and Raabe, CPAs

5191 Natorp Boulevard Mason, OH 45040

August 8, 2003 Ms. Helen Carlon 500 Monticello Avenue Glendale, AZ 85306

Dear Ms. Carlon:

In response to your inquiry regarding the appropriate depreciation method for the

$250,000 of equipment placed in service during March 2003, two options are available. The first will produce a larger depreciation deduction, but may result in the AMT being paid. The second option will produce a smaller depreciation deduction, but will have no effect on the AMT.


Under the first option, depreciation is calculated using the 200% declining balance method with a 5-year recovery period. The amount of the depreciation deduction under this method is $50,000 ($250,000 X 20%). However, for AMT purposes, the depreciation is calculated using the 150% declining balance method with a 5-year recovery period. The amount of the depreciation deduction for AMT purposes is $37,500 ($250,000 X 15%). Therefore, for AMT purposes, there will be a positive adjustment of $12,500 ($50,000 – $37,500).

Under the second option, depreciation for regular income tax purposes and AMT

purposes is calculated using the depreciation method and recovery period required for AMT purposes. Thus, in both cases, the amount of the depreciation deduction is $37,500. The benefit of electing to calculate the regular income tax depreciation this way is that the aforementioned positive adjustment for AMT purposes is avoided.

Whether the election that produces a smaller depreciation deduction for regular

income tax purposes but avoids a positive AMT adjustment is beneficial depends on your AMT status absent the effect of the depreciation deduction. In order to advise you regarding this election, I need to meet with you to obtain additional tax information. Please provide me with a date and time that is convenient to you.

Sincerely, James Singer, CPA Partner pp. 14-12 and 14-13

40. a. Mining exploration and development costs can be expensed in the year incurred for regular income tax purposes. These expenditures must be amortized over a 10-year period for AMT purposes. Gary’s regular income tax deduction would be $600,000 in 2003 and his AMT deduction would be $60,000 ($600,000/10). Therefore, Gary would have a positive adjustment of $540,000 in 2003 ($600,000 regular income tax deduction – $60,000 AMT deduction). His negative adjustment for each of the next nine years will be $60,000 ($0 regular income tax deduction – $60,000 AMT deduction).

b. Gary can avoid having an adjustment by electing to amortize the mining

exploration and development costs over a ten-year period for regular income tax purposes.

c. Gary should consider the present value of the cash flows, different tax brackets

between regular income tax and AMT, and the possible effect this adjustment will have on future AMT calculations.

Example 9 and related discussion


41. For 2003, there is a positive AMT adjustment of $120,000.

AMT: Revenues ($500,000 X 60%) $300,000 Expenses (180,000) $120,000

Regular income tax: Revenues $ -0- Expenses (-0-) (-0-)

AMT adjustment $120,000 For 2004, there is a negative AMT adjustment of $120,000. AMT:

Revenues ($500,000 – $300,000) $200,000 Expenses ($295,000 – $180,000) (115,000) $ 85,000

Regular income tax: Revenues $500,000 Expenses (295,000) (205,000)

AMT adjustment ($120,000) p. 14-14 42. a. For regular income tax purposes and for AMT purposes, there are no tax results

which need to be reported in 2003, the year of grant.

b. For regular income tax purposes and for AMT purposes, there are no tax results which need to be reported in 2007, the year of exercise.

c. For regular income tax purposes, the spread of $30,000 ($100,000 fair market

value – $70,000 option price) is not recognized in 2008, the year when rights in the stock become freely transferable and are not subject to a substantial risk of forfeiture. For AMT purposes, however, the spread of $30,000 is a positive AMT adjustment in 2008.

d. The regular income tax basis of $70,000 is different from the AMT basis of

$100,000 ($70,000 + $30,000). Thus, there is a negative AMT adjustment in 2011, the year of sale, of $30,000 ($80,000 – $50,000).

Regular Income Tax AMT Amount realized $150,000 $150,000 Amount basis (70,000) (100,000) Recognized gain $ 80,000 $ 50,000

pp. 14-14 and 14-15 43. In 2003, when the rights become freely transferable and are not subject to a substantial

risk of forfeiture, Diego has a positive $27,000 adjustment for AMT purposes [($92 – $65) X 1,000 shares]. The transaction has no effect on regular taxable income or alternative minimum taxable income in 1998. There is no effect on regular taxable income in 2003 when the rights in the stock become freely transferable and are not subject to a substantial risk of forfeiture.


When the stock is sold in 2004, the recognized gain for regular income tax purposes and AMT purposes is calculated as follows:

Regular Income Tax AMT Amount realized $100,000 $100,000 Amount basis (65,000) (92,000) Recognized gain $ 35,000 $ 8,000

The AMT basis is the fair market value on the exercise date (i.e., $92 per share). Since

the gain on the sale for regular income tax purposes exceeds the recognized gain for AMT purposes, there is a $27,000 negative adjustment in calculating AMT. pp. 14-14 and 14-15

44. a. Alicia has a recognized gain for both regular income tax and AMT purposes. Regular Income Tax AMT Building Land Building Land Amount realized $800,000 $250,000 $800,000 $250,000 Adjusted basis (450,000) (100,000) (490,000) (100,000) Realized gain $350,000 $150,000 $310,000 $150,000 Recognized gain $350,000 $150,000 $310,000 $150,000

b. There is no AMT adjustment associated with the sale of the land because the recognized gain for regular income tax purposes and AMT purposes is the same ($150,000).

There is a negative AMT adjustment associated with the sale of the apartment

building of $40,000 ($310,000 – $350,000). This results because the cost recovery deductions on the building for regular income tax purposes exceed those for AMT purposes by $40,000 ($450,000 adjusted basis – $490,000 adjusted basis).

Recognized gain: regular income tax $350,000 Recognized gain: AMT (310,000) Negative AMT adjustment $ 40,000 pp. 14-15 and 14-16 45. The 2003 loss will not be deductible either for regular income tax or AMT purposes,

since no passive income is present. The suspended passive loss for regular income tax purposes is $11,750 ($160,000 gross income – $122,000 operating expenses – $49,750 regular income tax depreciation). The suspended passive loss for AMT purposes is $3,000 ($160,000 gross income – $122,000 operating expenses – $41,000 ADS depreciation). Examples 15 and 16 and related discussion

46. a. All of the medical expenses are eligible for the medical expense deduction.

Therefore, for regular income tax purposes, Wally’s and Gloria’s medical expense deduction is $14,500 [$29,500 – 7.5%($200,000)].

b. For AMT purposes, only the medical expenses in excess of 10% of AGI can be

deducted. Therefore, the medical expense deduction is $9,500 [$29,500 – 10% ($200,000)].


c. The AMT adjustment for medical expenses is a positive adjustment of $5,000 ($14,500 – $9,500).

pp. 14-18 and 14-19

47. a. Wolfgang’s itemized deductions for AMT purposes are calculated as follows: Medical expenses [$5,500 – (10% X $60,000)] $ -0- Charitable contributions 7,000 Qualified housing interest 6,000 Casualty loss 1,500 Total $14,500

Neither the state income taxes of $4,200 nor the miscellaneous itemized deductions of $3,300 are deductible for AMT purposes. An additional 2.5% of AGI ($1,500) is disallowed in calculating medical expenses. Thus, none of the medical expenses are deductible.

b. The AMT adjustment is calculated as follows: Itemized deductions for regular income tax $23,000 Less: Itemized deductions for AMT purposes (14,500) Positive AMT adjustment $ 8,500

pp. 14-18 to 14-21 48. For regular income tax purposes, the following amounts are deductible as qualified

residence interest:

Interest on personal residence $12,000 Interest on cabin 4,800 Interest on home equity loan 5,000 Total qualified residence interest deduction $21,800 For AMT purposes, however, the deduction is limited to qualified housing interest, which includes the following: Interest on personal residence $12,000 Interest on cabin 4,800 Total qualified housing interest deduction $16,800 Interest on the home equity loan is not deductible for AMT purposes because the proceeds were not used to substantially improve a qualified residence. Therefore, an AMT adjustment is required: Total qualified residence interest deduction $21,800 Total qualified housing interest deduction (16,800) Positive AMT adjustment $ 5,000 pp. 14-19 and 14-21

49. For regular income tax and AMT purposes, investment interest expense is limited to net investment income. Therefore, Yoon’s regular income tax deduction for investment interest expense is limited to $10,000 (the amount of dividends received). For regular


income tax purposes, the private activity bond interest of $5,000 is excludible from gross income and the related $3,500 interest expense is not deductible. The $5,000 interest income on the private activity bonds is offset by the $3,500 interest expense, so Yoon reports a $1,500 tax preference for AMT purposes. In addition, the net investment income of $1,500 ($5,000 – $3,500) from the private activity bonds is treated as part of net investment income for AMT purposes. Net investment income is $11,500 ($10,000 + $1,500). Therefore, for AMT purposes, $11,500 of the $13,000 investment interest expense can be deducted. pp. 14-20 and 14-21

50. a. Walter and Edith’s itemized deductions are calculated as follows:

Regular Income Tax AMT Adjustment Medical expenses (see Note 1) $ 1,250 $ -0- $ 1,250 State income taxes 2,800 -0- 2,800 Personal property tax 900 -0- 900 Real estate tax 9,100 -0- 9,100 Interest on residence 8,600 8,600 -0- Interest (home equity) 1,800 -0- 1,800 Investment interest 2,600 2,600 -0- Charitable contribution 4,200 4,200 -0- Employee expenses (Note 2) 1,600 -0- 1,600 Totals $32,850 $15,400 $17,450 NOTES (1) Medical expenses: For regular income tax [$9,500 – (7.5% X $110,000)] $1,250 For AMT [$9,500 – (10% X $110,000)] -0- Positive adjustment $1,250 (2) Unreimbursed employee expenses: Expenses $3,800 2% of AGI ($110,000) (2,200) Deduction for regular income tax $1,600 pp. 14-18 to 14-21 b. Walter and Edith would have a positive adjustment of $17,450, as computed

above. In addition, they would have a tax preference of $1,100 ($5,000 interest on private activity bonds – $3,900 related interest expense). pp. 14-18 to 14-21

51. There are positive AMT adjustments of $4,750 for the standard deduction and $3,050 for

the personal exemption. Alternative minimum taxable income is $207,800 ($82,000 taxable income + $118,000 preferences + $4,750 standard deduction + $3,050 exemption). Examples 24 and 25 and related discussion

52. Emily’s percentage depletion deduction for regular income tax purposes is $21,000

($140,000 income X 15% depletion rate). This results in a tax preference of $9,000 ($21,000 percentage depletion – $12,000 basis at beginning of year). Example 26


53. Amos’s preference item for IDC is computed as shown below: IDC expensed in the year $70,000 Less: IDC if amortized over 10 years (7,000) Excess IDC $63,000 Less: 65% of $60,000 net income from oil and gas (39,000) IDC preference $24,000

p. 14-22 54. $9,000 interest on private activity bonds + $35,000 bargain element on incentive stock

options + $4,750 standard deduction + $3,050 personal exemption = $51,800. pp. 14-14, 14-21, and 14-23

55. Pat’s tentative AMT for 2003 is computed as shown below: Taxable income computation

Salary $ 90,000 Interest and dividend income 6,000 Gambling income 4,000 Adjusted gross income $100,000

Itemized deductions: Medical expenses ($12,000 – $7,500) $4,500 State income taxes 4,100 Real estate taxes 2,800 Mortgage interest on residence 3,100 Investment interest expense 1,800 Gambling losses (limited to gambling income) 4,000

Total itemized deductions (20,300) Personal exemption (3,050) Taxable income $ 76,650

Tentative minimum tax computation Taxable income $ 76,650 Plus adjustments: Medical expenses 2,500 Regular income tax [$12,000 – (7.5% X $100,000) = $4,500] AMT [$12,000 – (10% X $100,000) = $2,000] State income taxes 4,100 Real estate taxes 2,800 Personal exemption 3,050 Subtotal $ 89,100 Plus: Preference (interest on private activity bonds) 40,000 Alternative minimum taxable income (AMTI) $129,100 Exemption [$35,750 – 25%($129,100 – $112,500)] (31,600) AMT base $ 97,500 AMT rate X .26 Tentative AMT $ 25,350 pp. 14-18 to 14-22


56. Based on the amount of Ronald’s standard deduction and number of personal and dependency exemptions, Ronald’s filing status is head of household. Therefore, Ronald’s regular income tax liability is $21,987 [$21,462 + 30%($100,000 – $98,250)]. Ronald’s AMT is calculated as follows:

Taxable income $100,000 Adjustments ($7,000 + $6,100) 13,100 Preferences 60,000 AMTI $173,100 Exemption [$35,750 – 25%($173,100 – $112,500)] (20,600) AMT base $152,500 Rate X 26% Tentative AMT $ 39,650 Regular income tax liability (21,987) AMT $ 17,663 pp. 14-3 to 14-10, 14-21, and Figure 14-2 57. a. Computation of Tara’s items of AMT adjustments and preferences for 2003: Incentive stock option adjustment $ 45,000 Excess depreciation on equipment preference ($41,000 – $26,000) 15,000 Percentage depletion in excess of property’s adjusted basis preference 50,000 Standard deduction adjustment 4,750 Personal exemption adjustment 3,050 Total adjustments and preferences $117,800 pp. 14-12, 14-14, 14-21, and 14-22

b. Calculation of alternative minimum tax:

Taxable income $121,000 Adjustments and preferences 117,800 Alternative minimum taxable income (AMTI) $238,800 Less: Exemption amount (Note 1) (4,175) Alternative minimum tax base $234,625 Tentative minimum tax (Note 2) $ 62,195 Less: Regular income tax on $121,000 (30,528) Alternative minimum tax $ 31,667 Regular income tax calculation

Tax on $121,000: On $68,800 $ 14,868 On ($121,000 – $68,800) at 30% 15,660 Total tax $ 30,528

Notes

(1) Exemption phase-out: ($238,800 – $112,500) X .25 = $31,575; then $35,750 – $31,575 = $4,175 exemption amount. pp. 14-8 and 14-9


(2) AMT tax calculations: $175,000 X 26% $45,500 ($234,625 – $175,000) X 28% 16,695 Tentative minimum tax $62,195

Concept Summary 14-1 and Examples 24 and 25

58. Gross income:

Salary $135,000 Interest from bank 12,000 Interest on corporate bonds 7,000 Dividends 6,000 Short-term capital gain 8,000 $168,000 Less: Deductions for AGI (-0-) Adjusted gross income $168,000 Less: Deductions from AGI Itemized deductions (Note 1) $ 31,685 Personal exemptions (Note 5) 2,318 (34,003)

Taxable income $133,997

Regular income tax calculation

Tax on $133,997: On $68,800 $ 14,868 On $133,997 – $68,800 at 30% 19,559 Total tax $ 34,427

Computation of alternative minimum tax:

Taxable income $133,997 Plus adjustments and preferences: Itemized deductions (Note 6) 17,285 Personal exemption 2,318 Preferences 116,000 Cutback adjustment (855) Alternative minimum taxable income $268,745

Less: Exemption [phaseout (Note 7): AMTI exceeds $255,500] (-0-) AMT base $268,745

Tentative AMT (Note 8) $ 71,749 Less: Regular income tax (34,427)

Alternative minimum tax $ 37,322

Notes

(1) Because Larry’s AGI exceeds $139,500, Category A itemized deductions are those subject to the cutback adjustment (i.e., subject to the 3% of AGI floor). p. 10-30


Category A Category B

Unreimbursed employee business expenses (Note 2) $ 640

Not subject to cutback adjustment: Medical expenses $11,400

State income taxes 6,500 Casualty loss (Note 4) -0-Real property taxes 6,800 Mortgage interest 7,200 Totals $21,140 $11,400

(a) Determine 80% limitation: (80% X $21,140 Category A deductions =

$16,912 maximum reduction).

(b) Determine 3% of the excess amount over the threshold: [3% X ($168,000 – $139,500) = $855].

(c) Subtract from the Category A itemized deductions the lesser of the amounts determined in Step a. or b.: ($21,140 – $855 = $20,285).

(d) Add the amount determined in Step c. to the Category B itemized deductions: ($20,285 + $11,400 = $31,685 total itemized deductions).

(2) Unreimbursed employee expenses $4,000 Less: 2% of $168,000 (3,360) Deductible amount $ 640

(3) Total medical expenses $24,000 Less: 7.5% of $168,000 (12,600)

Deductible amount $11,400

(4) Casualty loss ($20,000 decline – $12,000 insurance – $100 floor) $ 7,900 Less: 10% of $168,000 AGI (16,800)

Deductible amount $ -0-

(5) Personal exemption phaseout: Personal exemption amount $3,050

AGI less threshold amount ($168,000 – $139,500) = $28,500 $28,500/$2,500 (rounded up) = 12 X 2% = 24% 24% X $3,050 = (732)

Personal exemption amount $2,318

(6) AMT itemized deductions: Mortgage interest $ 7,200 Medical expenses [$24,000 – 10%($168,000)] 7,200 Total $14,400

Regular income tax itemized deductions (Note 1) $31,685 Less: AMT itemized deductions (14,400)

Positive adjustment $17,285


(7) AMT exemption phaseout: Exemption amount $35,750

Less: Reduction [($268,745 – $112,500) X 25%] (39,061) Exemption $ - 0 –

(8) AMT tax calculation: $175,000 X 26% $45,500 ($268,745 – $175,000) X 28% 26,249 Tentative minimum tax $71,749

pp. 14-18 to 14-22

59. AMT computation Taxable income $ -0- Plus: Timing adjustments 200,000 Plus: AMT exclusion items 100,000 AMTI $300,000 Minus: Exemption [$35,750 – .25($300,000 – $112,500)] (-0-) AMT base $300,000 Tentative AMT [.26($175,000) + .28($300,000 – $175,000)] $ 80,500 Minus: Regular income tax liability (-0-) AMT $ 80,500 AMT without timing adjustments Taxable income $ -0- Plus: AMT exclusion items 100,000 AMTI $100,000 Minus: Exemption [$35,750 – .25($100,000 – $112,500)] (35,750) AMT base $ 64,250 Tentative AMT (.26 X $64,250) $ 16,705 Minus: Regular income tax liability (-0-) AMT $ 16,705 Credit carryover computation AMT $ 80,500 Less: AMT without timing adjustments (16,705) AMT credit carryover $ 63,795

Examples 29 to 31 60. a. Aqua is first exempt from the AMT for 1998 (the first year for which the

exemption is available) as a “small corporation.” Aqua is classified as a small corporation if (1) it had average annual gross receipts of $5 million or less for the three-year period beginning after December 31, 1993 and (2) it had average annual gross receipts for each subsequent three-year period of $7.5 million or less (i.e., 1995, 1996, and 1997 if the tax year is 1998; 1996, 1997, and 1998 if the tax year is 1999; 1997, 1998, and 1999 if the tax year is 2000; 1998, 1999, and 2000 if the tax year is 2001; 1999, 2000, and 2001 if the tax year is 2002; 2000, 2001, and 2002 if the tax year is 2003). For the three-year period which includes 1994, 1995, and 1996, Aqua had average annual gross receipts of:


$4,800,000 + $5,300,000 + $4,600,000

3 years = $4,900,000

Thus, Aqua passes the $5 million test for this period. For the three-year period which includes 1995, 1996, and 1997, Aqua had average annual gross receipts of:

$5,300,000 + $4,600,000 + $8,200,000

3 years = $6,033,333

Thus, Aqua passes the $7.5 million test for this period. Aqua is a small corporation for 1998. Thus, it is exempt from the AMT for 1998.

b. Aqua remains exempt from the AMT in 2003. In order to do so, Aqua’s average annual gross receipts for the three-year period consisting of 1996, 1997, and 1998 do not exceed $7.5 million.

$4,600,000 + $8,200,000 + $8,500,000

3 years = $7,100,000 Likewise, Aqua’s average annual gross receipts for the three-year period

consisting of 1997, 1998, and 1999 do not exceed $7.5 million.

$8,200,000 + $8,500,000 + $5,200,0003 years = $7,300,000

Likewise, Aqua’s average annual gross receipts for the three-year period consisting of 1998, 1999, and 2000 do not exceed $7.5 million.

$8,500,000 + $5,200,000 +$8,000,0003 years = $7,233,333

Likewise, Aqua’s average annual gross receipts for the three-year period consisting of 1999, 2000, and 2001 do not exceed $7.5 million.

$5,200,000 + $8,000,000 + $6,000,000

3 years = $6,400,000

Finally, Aqua’s average annual gross receipts for the three-year period consisting of 2000, 2001, and 2002 do not exceed $7.5 million.

$8,000,000 + $6,000,000 + $6,200,000

3 years = $6,733,333

pp. 14-29 61. 2002 2003 2004

ACE $4,000 $3,000 $2,000 Less: Unadjusted AMTI (3,000) (2,000) (5,000) Difference $1,000 $1,000 ($3,000) Rate X .75 X .75 X .75 Adjustment $ 750 $ 750 ($1,500)*


*$2,250 ($3,000 X .75) but limited to $750 + $750, or $1,500. Further, the unusable negative adjustment of $750 ($2,250 – $1,500) is lost forever. Concept Summary 14-2, Example 32, and related discussion

62. Quincy Corporation:

AMTI $150,000 Less: Exemption amount (40,000) AMT base $110,000 Rate X .20 Tentative AMT $ 22,000 Note: In this case, there is no reduction in the exemption amount because AMTI does not exceed $150,000. Redland Corporation: Step 1 AMTI $160,000 Less: Threshold amount for exemption (150,000) Amount by which AMTI exceeds $150,000 $ 10,000 Reduction rate X .25 Applicable reduction in exemption amount $ 2,500 Step 2 Exemption amount $ 40,000 Less: Reduction in exemption amount from Step 1 (2,500) Applicable exemption amount $ 37,500 Step 3 AMTI $160,000 Less: Applicable exemption amount from Step 2 (37,500) AMT base $122,500 Rate X .20 Tentative AMT $ 24,500 Tanzen Corporation: Step 1 AMTI $320,000 Less: Threshold amount for exemption (150,000) Amount by which AMTI exceeds $150,000 $170,000 Reduction rate X .25 Applicable reduction in exemption amount $ 42,500 Step 2 Exemption amount $ 40,000 Less: Reduction in exemption amount from Step 1 (42,500) Applicable exemption amount $ -0-


Step 3 AMTI $320,000 Less: Applicable exemption amount from Step 2 (-0-) AMT base $320,000 Rate X .20 Tentative AMT $ 64,000 Note: In this case, the exemption amount is phased out entirely because AMTI exceeds $310,000.

pp. 14-27 and 14-32 63. a. Tax on taxable income of $3,000,000: $3,000,000 X 34% = $1,020,000

b. Taxable income $3,000,000 Adjustments and tax preferences: Depreciation for regular income tax on realty in excess of ADS straight-line $150,000 Excess amortization of certified pollution control facilities 450,000 Tax-exempt interest on private activity bonds 30,000 Percentage depletion in excess of the property’s adjusted basis 60,000 690,000 AMTI $3,690,000 Less: Exemption (AMTI exceeds $310,000) (-0-) Alternative minimum tax base $3,690,000 AMT tax rate X .20 Tentative AMT ( no foreign tax credit) $ 738,000 c. Tentative AMT $ 738,000 Less: Regular income tax liability (1,020,000) AMT $ -0- pp. 14-27 to 14-32

CUMULATIVE PROBLEMS 64. Regular income tax computation: Free housing (Note 1) $ -0- Grocery allowance (Note 2) 13,000

Short-term capital gain 38,000 Dividend and interest income (Note 3) 37,000 Lottery winnings 10,000 Incentive stock option exercise (Note 4) -0- Life insurance proceeds (Note 5) -0- AGI before rental loss and alimony $98,000 Real estate rental loss (Note 6) (25,000) Alimony (24,000)


Adjusted gross income $49,000 Itemized deductions: Charitable contribution (Note 7) $5,200 Consumer interest (Note 8) -0- State and local income taxes 4,600 Medical expenses [$7,500 – (7.5% X $49,000 AGI)](Note 9) 3,825 Gambling losses (Note 10) 8,000 Miscellaneous itemized deductions (Note 11) -0- (21,625) Personal exemption (3,050) Taxable income $24,325 Income tax on $24,325 (Note 12) $ 3,349 AMT computation: Taxable income $ 24,325 Adjustments and preferences: Incentive stock option adjustment $50,000 State and local income taxes 4,600 Medical expenses (Note 13) 1,225 Personal exemption 3,050 Interest on private activity bonds 40,000 Total adjustments and preferences 98,875 Alternative minimum taxable income $123,200 Less: AMT exemption [$35,750 – 25%($123,200 – $112,500)] (33,075) AMT base $ 90,125 AMT rate X .26 Tentative AMT $ 23,433 Less: Regular income tax (3,349) AMT $ 20,084 2003 Tax Liability Regular income tax liability $ 3,349 Alternative minimum tax 20,084 Total tax liability $23,433 Note 1 Because Ron is a minister of the gospel, he can exclude the fair rental value of the parsonage of $2,000 per month. Note 2 The grocery allowance of $250 per week does not qualify for the § 119 meal exclusion. Note 3 The $40,000 of interest on private activity bonds is excludible from gross income. Note 4 The spread on the ISO of $50,000 ($70,000 – $20,000) is not recognized in 2003.


Note 5 The life insurance proceeds of $500,000 are excludible from Ron’s gross income.

Note 6 Loss on rental property: Because Ron is an active participant, he may deduct part of the $55,000 loss ($190,000 – $245,000) under the rental real estate exception. Because his AGI is less than $100,000, the loss allowed under the rental real estate exception is $25,000. The balance of the loss of $30,000 is suspended. p. 10-23 Note 7 Because the holding period of the stock is long-term and the stock is an intangible asset, the full fair market value of $3,200 qualifies for the charitable contribution deduction. The $2,000 he gave to the church from the lottery also qualifies. Note 8 The $3,700 of consumer interest cannot be deducted. Note 9 The $8,500 of medical expenses paid by Ron for the hospital expenses of Kate’s deceased husband are not deductible by Ron because he was not Ron’s dependent. Note 10 Gambling losses can be deducted only to the extent of gambling income. Thus, all of the $8,000 of gambling losses from the lottery can be deducted since the gambling winnings are $10,000. Note 11 Miscellaneous itemized deductions are deductible only to the extent they exceed 2% of AGI ($49,000 X 2% = $980). The $200 for the safe deposit box rental is classified as a miscellaneous itemized deduction. Since the $200 is less than the $980, none of it can be deducted. Note 12 Tax on $6,000 $ 600 15% X ($24,325 – $6,000) 2,749 $3,349 Note 13 Regular income tax medical deduction $3,825 AMT medical deduction (2,600)* Medical deduction positive adjustment $1,225 * $7,500 – (10% X $49,000) = $2,600 medical deduction.


65. Robert and Jane have taxable income for 2002 as follows: Salary for Robert (Indiana Foundry, Inc.) $ 89,000 Salary for Jane (Carmel Computer Associates) 102,000 Interest income (Carmel National Bank) (Note 1) 3,300 Dividend income (Able Computer Corporation) 3,500 Gambling income (Note 2) 4,000 Award income (Note 3) 15,000 Capital gain (Note 4) 13,000 Adjusted gross income $229,800 Deductions from AGI Itemized deductions: Medical expenses [$19,725 – 7.5% X $229,800 AGI)] $ 2,490 State income tax ($3,970 + $4,710) 8,680 Real property tax on personal residence 4,600 Mortgage interest on personal residence 7,500 Investment interest expense 1,900 Contributions ($11,000 + $2,000) 13,000 Gambling losses (Note 2) 4,000 Subtotal $42,170 Minus: reduction under 3% cutback adjustment (2,775) (Note 5) Total itemized deductions (39,395) Exemptions (Note 6) (9,600) Taxable income $180,805 Alternative minimum tax for Robert and Jane is computed as shown below. Taxable income plus exemptions ($180,805 + $9,600) $190,405 Reduction caused by 3% cutback adjustment for itemized deductions (2,775) (Note 5) Subtotal $187,630 Adjustments: Medical expenses [$2,490 for regular income tax – $0 for AMT (Note 7)] $ 2,490 Taxes ($8,680 state income tax + $4,600 real property tax) 13,280 Total adjustment for itemized deductions 15,770 Preference: Interest on private activity bonds 30,200 Alternative minimum taxable income (AMIT) $233,600 Less: Exemption (Note 8) (28,100) Alternative minimum tax base $205,500 Less: Amount eligible for alternative tax on net capital gain (13,000)

AMT base subject to ordinary tax rates $192,500


Tentative AMT liability on $192,500 (Note 12) $50,400 Tentative AMT liability on $13,000 (Note 13) 2,600 Tentative AMT $53,000

Less: Regular income tax liability (Note 9) (43,352) AMT $ 9,648 Note 1 – excludible interest income The Carmel Sanitation District Bonds interest income of $30,200 is excluded from gross income. Note 2– gambling income and losses Since their gambling losses of $5,750 exceed the gambling income of $4,000, the excess loss of $1,750 is disallowed. The $4,000 of gambling income is included in gross income and the allowed $4,000 of gambling losses are classified as an itemized deduction. Note 3 – award received The $15,000 that Jane received for the “Citizen of the Year” is included in her gross income. Note 4 – sale of land Robert’s adjusted basis for the land he purchases is $67,000. So his recognized gain on the sale of the land is $13,000 ($80,000 amount realized – $67,000 adjusted basis). Robert’s holding period is long term. The gain is classified as long-term capital gain and is eligible for the alternative tax rate.

Note 5 - reduction for 3% cutback adjustment for itemized deductions This computation determines the reduction in itemized deductions from application of the 3% cutback adjustment. The computation follows the format provided by the IRS in the instructions for Schedule A. Medical expenses [$19,725 – (7.5% X $229,800 AGI)] $ 2,490 State income tax 8,680 Real property tax on personal residence 4,600 Mortgage interest on personal residence 7,500 Investment interest expense 1,900 Contributions 13,000 Gambling losses 4,000 Total itemized deductions $42,170 Medical expenses [$19,725 – (7.5% X $229,800 AGI)] $2,490 Investment interest expense 1,900 Gambling losses 4,000 Total of itemized deductions not subject to reduction (8,390) Itemized deductions subject to reduction $33,780 80% of $33,780 = maximum cutback adjustment $27,024 AGI $229,800 Less: Threshold for married, joint return (137,300) Excess AGI $ 92,500 3% of $92,500 excess AGI $ 2,775


Reduction (smaller of $27,024 or $2,775) $ 2,775 Note 6 – dependency deductions and phaseout

Robert and Jane qualify for four personal and dependency exemptions. The two dependency deductions are for the twins, Ellen and Sean. They do not qualify for a dependency deduction for Robert’s daughter, Amy, even though Robert provides over 50% of her support. Margaret, Robert’s former wife, is the custodial parent, and she does not furnish Robert with a signed Form 8332.

$3,000 X 4 = $12,000

However, because Robert and Jane’s AGI exceeds the threshold amount, the personal and dependency exemptions are subject to the phaseout provision.

AGI $229,800 Less: Threshold amount (206,000) Excess $ 23,800 Divided by $2,500 = 9.52% Round to 10% X 2% = Phaseout percentage 20% Amount of phaseout ($12,000 X 20%) $ 2,400 Personal and dependency exemptions $12,000 Less: Phaseout (2,400)

Deductible personal and dependency exemptions $ 9,600

Note 7 - AMT medical deduction $229,800 X 10% = $22,980 $19,725 – $22,980 = $0 medical deduction for AMT.

Note 8 - alternative minimum tax exemption The AMT exemption phase-out for a married couple filing jointly applies if alternative minimum taxable income (AMTI) exceeds $150,000. The Armstrong’s have AMTI of $233,600, so the $49,000 exemption is reduced as follows:

AMTI $233,600 Less: Threshold (150,000) Excess $ 83,600 X 25% X 25% Amount of phaseout $ 20,900 Exemption amount $ 49,000 Less: Amount of phaseout (20,900)

Deductible exemption amount $ 28,100


Note 9 - regular income tax liability Taxable income $180,805 Tax on $171,950 $ 41,996 35% X ($180,805 – $171,950) 3,099 $ 45,095 However, since the $13,000 long-term capital gain on the sale of the land is eligible for the alternative tax on net capital gain, Robert and Jane’s regular income tax liability is $43,352 rather than the $45,095 calculated above.

Tax on $167,805 ($180,805 – $13,000): Tax on $112,850 $24,266 30% X ($167,805 – $112,850) 16,486 $40,752

Plus: Tax on net capital gain of $13,000: $13,000 X 20% 2,600 $43,352

Note 10 – holding period for the land Robert’s holding period begins on March 15, 1997. Note 11 – Jane’s inheritance The $600,000 that Jane inherited from her grandfather is excluded from Jane’s gross income. Note 12 – tentative AMT liability on AMT base subject to ordinary tax rates

$175,000 X 26% = $45,500 17,500 X 28% = 4,900 $192,500 $50,400

Note 13 – tentative AMT liability on AMT base eligible for alternative tax on net capital gain The $13,000 amount that qualifies for the alternative tax treatment for regular income tax purposes also qualifies for alternative tax treatment for AMT purposes.

$13,000 X 20% = $2,600

Note 14 – child tax credit The twins, Ellen and Sean, satisfy the statutory requirements for the child tax credit. However, Robert and Jane’s AGI of $229,800 results in a full phaseout of the credit (i.e., the phaseout commences at an AGI of $110,000). See the tax return solution beginning on p. 14-34 of the Solutions Manual.


Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard

Mason, OH 45040

April 2, 2003 Mr. and Mrs. Robert Armstrong 1802 College Avenue Carmel, IN 46302 Dear Bob and Jane: Your 2002 income tax return is enclosed and indicates that you have a refund of $2,000 ($53,000 tax liability – $55,000 withholdings). Because the Carmel Sanitation District bonds are private activity bonds subject to the alternative minimum tax, $9,648 of the total tax owed is due to the alternative minimum tax. In order to avoid this tax in the future, you might consider changing the investment to tax-free bonds which are not private activity bonds and, therefore, not subject to the alternative minimum tax. If you have any questions, please call me. Sincerely, John Jones, CPA Partner


65.


65. continued


NOTES

CHAPTER 14 ALTERNATIVE MINIMUM TAX SOLUTIONS TO …isu.indstate.edu/acharmo/smpdf/CH14.pdf ·...

Documents

Transcript of CHAPTER 14 ALTERNATIVE MINIMUM TAX SOLUTIONS TO …isu.indstate.edu/acharmo/smpdf/CH14.pdf ·...