Vol 01 chapter 12 2015

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Individual Income Taxes

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Chapter 12

Alternative Minimum Tax

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The Big Picture (slide 1 of 2)

• Bob and Carol are unmarried individuals who have been engaged for four months. They work for the same employer and – They earn identical compensation. – They have the same amount of gross income, including the

same amount of investment income, which consists solely of interest income.

– They have similar investments in tax-exempt bonds that produce identical amounts of interest income.

– They also have the same amount of deductions.

• Carol learns that she paid $15,000 more in Federal income taxes than Bob did for the tax year.

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The Big Picture (slide 2 of 2)

• The above events raise a number of interesting questions for Bob and Carol that can be answered after completing this chapter. – Why didn’t Bob and Carol have the same tax liability? – Were both tax returns properly prepared? – Should Carol consider replacing her tax return preparer

Ava with Adam? – Is it possible and/or desirable for Carol to file an amended

return? – Should Bob do anything?

• Read the chapter and formulate your response.

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Alternative Minimum Tax (AMT)

• AMT is separate from, but parallel to, the regular income tax system

• The AMT computation reconciles taxable income, through adjustments and preferences, with Alternative Minimum Taxable Income (AMTI)

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Computation of AMT

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AMT Adjustments And Preferences (slide 1 of 3)

• Most AMT adjustments relate to timing differences – Timing differences eventually reverse

• Positive adjustments will be offset by negative adjustments in the future, and vice versa

– Example - circulation expenditures • For regular income tax purposes, circulation expenditures can be deducted

in the year incurred• For AMT purposes, however, circulation expenditures must be deducted

over a three-year period

• Certain AMT adjustments do not relate to timing differences – These adjustments result in a permanent difference between taxable

income and AMTI• e.g., Itemized deductions

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AMT Adjustments And Preferences(slide 2 of 3)

• AMT Preferences– Designed to take back all or part of the tax benefits

obtained by certain items in the computation of taxable income for regular income tax purposes

• Taxable income is increased by tax preference items effectively disallowing those tax benefits for AMT purposes

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AMT Adjustments And Preferences(slide 3 of 3)

• Tax preferences include:– Percentage depletion in excess of basis– Excess intangible drilling costs– Interest on certain private activity bonds– Excess of accelerated over straight-line depreciation on

real & leased personal property placed in service before 1987

– Excess of amortization allowance over depreciation on pre-1987 certified pollution control facilities

– 7% of the exclusion from gross income of gains on the sale of certain small business stock

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Other Components of AMT(slide 1 of 3)

• Exemption amount– The exemption reduces AMTI to arrive at the base

on which AMT is computed– The initial exemption amount in 2014 is:

• $52,800 for single

• $82,100 for married, filing jointly

• $41,050 for married, filing separately

– The exemption is phased out at a rate of 25 cents on the dollar when AMTI exceeds certain amounts

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• For 2014, the exemption and phaseout amounts are as follows:

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• AMT rates– A progressive rate structure is applied to the tax

base (AMTI less exemption amount)• 26% on first $182,500 ($91,250 for married, filing

separately) of tax base

• 28% on remaining amount of tax base

– Net capital gain and qualified dividend income included in AMT base are taxed at favorable alternative tax rates (0%, 15%, or 20%)

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Personal Tax Credits

• Beginning in 2012, personal nonrefundable credits are allowed to offset any AMT liability as well as any regular tax liability – e.g., Adoption Credit, Lifetime Learning Credit,

and Retirement Savings Contribution Credit

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AMT Adjustments (slide 1 of 15)

• Adjustments tend to arise from timing differences between regular tax and AMT– Adjustments can be positive or negative, and will

generally reverse in later years

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Adjustments (slide 2 of 15)

• The AMT depreciation adjustment for real property applies only to real property placed in service before January 1, 1999

• For real property placed in service after December 31, 1998, MACRS recovery periods apply for AMT– Thus, the AMT adjustment is effectively

eliminated

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• For real property placed in service after 1986 (MACRS property) and before January 1, 1999– AMT depreciation is computed under the

alternative depreciation system (ADS)• Uses the straight-line method over a 40-year life

– Regular tax MACRS lives are 27.5, 31.5, and 39 years

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• Depreciation of post-1986 personal property– AMT method is 150% DB over ADS life– Regular tax is generally MACRS method based on

200% DB over shorter lives

• Effective for personalty placed in service after 12/31/98, MACRS recovery periods are to be used for AMT– If 150% DB is elected for this property, there is no

AMT adjustment

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• Pollution control facilities– Depreciate under the ADS over appropriate class

life for AMT• Amortize over 60 months for regular tax purposes

– Effective for pollution control facilities placed in service after 12/31/98, MACRS recovery periods are to be used for AMT

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• Circulation expenditures– Amortized over 3 years for AMT

• Expensed in year incurred for regular tax

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• Mining exploration/development costs and research/experimental expenditures– Amortized over 10 years for AMT

• Expensed in year incurred for regular tax purposes

– Taxpayer may elect to capitalize and amortize over 10 years for regular tax purposes and thus avoid the AMT adjustment

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• Completed contract method– AMT requires the use of percentage of completion

method for long-term contracts rather than completed contract method

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• Incentive stock options (ISOs)– The exercise of an ISO can cause income for AMT

purposes that is not currently taxable for regular tax purposes

• Excess of FMV over exercise price is adjustment in the taxable year in which the option is exercised

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• Adjusted gain or loss– Since the adjusted basis of an asset can be different

for regular tax and AMT, gain or loss recognized upon the disposition of an asset may vary for the two tax systems

– Difference between regular tax gain (loss) and AMT gain (loss) is adjustment

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• Passive activity losses - Not deductible in computing either the regular income tax or the AMT– Passive losses must still be recomputed for AMT using

AMT provisions

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• Net operating loss (NOL)– NOL must be recomputed for AMT using AMT

provisions

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• Itemized deductions allowed for AMT purposes include:

• Casualty losses

• Gambling losses

• Charitable contributions

• Medical expenses in excess of 10% of AGI

• Estate tax attributable to IRD

• Qualified interest– May differ from regular tax since only student loan, qualified

residence, and investment interest are deductible for AMT

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• Itemized deductions not allowed for AMT:– Taxes and miscellaneous itemized deductions

subject to the 2% AGI limit

• Gross income may include a refund of taxes deducted in prior years as an itemized deduction – A negative AMT adjustment is allowed for such

refunds for AMT purposes

• The 3% cutback of regular income tax itemized deductions does not apply for AMT

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• Other adjustments– AMT does not allow the standard deduction and

personal and dependency exemptions• These adjustments enter the AMTI calculation

indirectly by adjusting the taxable income amount that begins the AMTI calculation

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Preferences (slide 1 of 5)

• Preferences tend to arise because of deductions or exclusions that provide substantial tax benefits – Unlike adjustments, preferences can only be

positive (i.e., increase AMTI)– Thus, preferences reduce the benefits initially

received when computing regular tax

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• Percentage depletion– Preference is the amount of percentage depletion

taken for regular tax which is in excess of the adjusted basis of the property at the end of the year

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• Intangible drilling costs– Deductible currently for regular tax– The AMT preference is computed as follows:

IDC expensed in the year incurred

Minus: Deduction if IDC were capitalized and amortized over 10 years

Equals: Excess of IDC expense over amortization

Minus: 65% of net oil and gas and geothermal income

Equals: Tax preference item

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• Interest on private activity bonds– This interest is not taxable for regular tax purposes

but is included in income for AMT purposes– Expenses incurred in carrying these bonds are not

deductible for regular tax purposes, but offset the interest income in computing the AMT preference

– Interest on private activity bonds issued after December 31, 2008 and before January 1, 2011 is not treated as a tax preference

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• 50% exclusion of gain on sale of certain small business stock normally is excludible from gross income for regular tax– For 2009 and 2010, the 50% is increased to 75%– For such stock acquired after September 2, 2010,

and before January 1, 2014, 100% of the gain is excluded from regular taxable income

– 7% of the excluded amount is a tax preference for AMT

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The Big Picture - Example 21

Private Activity Bonds• Return to the facts of The Big Picture on p. 12-1.

• Bob and Carol both have invested substantial amounts in private activity bonds all of which were issued in 2010. – A tax preference does not result for either Carol or

Bob.

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AMT Credit

• AMT attributable to timing differences is AMT Credit– Excess of AMT over AMT computed without

timing differences

• AMT credit can be carried forward (indefinitely) to be used to offset regular income tax liability– Cannot carryback or use against AMT liability

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Corporate AMT(slide 1 of 4)

• Major differences in AMT rules for corporations– AMT rate is a flat 20%– Exemption amount is $40,000

• Reduced by 25% of amount by which AMTI exceeds $150,000

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• Major differences in AMT rules for corporations (cont’d)– Adjusted current earnings (ACE) adjustment

• Adjustment = 75% × (ACE - AMTI before ACE)

• ACE employs some earnings and profits concepts but certain differences exist

• Adjustment can be positive or negative– The negative adjustment is limited to the aggregate positive

adjustments under ACE for prior years

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• AMT is repealed for small corporations for tax years beginning after 12/31/97– A corporation is classified as a small corporation if both of

the following apply• It was treated as a small corporation exempt from the AMT for all

prior years beginning after 1997

• Average gross receipts for the 3 year period ending before its current tax year did not exceed $7.5 million

– $5 million if the corporation had only one prior tax year

– However, if a corporation ever fails the gross receipts test, it is ineligible for small corporation classification in future tax years

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• A new corporation is automatically classified as a small corporation its first tax year of existence

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Minimum Tax Credit

• All of a corporation’s AMT is available for carryover as a minimum tax credit– Does not matter whether the adjustments and

preferences originate from timing differences or AMT exclusions

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Refocus On The Big Picture

• Bob contacts Adam, his tax return preparer, and explains in an excited voice that he believes that he underpaid his Federal income tax liability for 2014 by $15,000. – He is worried about the negative effects of an IRS audit.

• Adam examines the two tax returns and discovers that the difference relates to the treatment of the interest earned on the tax-exempt bonds. – Both Bob and Carol own tax-exempt bonds, including private activity

bonds that usually are subject to the AMT. – However, Carol’s accountant, Ava, apparently overlooked the fact that

interest on private activity bonds is not a tax preference for private activity bonds issued in 2010.

• So the $15,000 AMT that was reported on Carol’s Form 6251 is in error. – Bob ‘‘texts’’ the good news to Carol that she is eligible for a Federal

income tax refund.

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 41

If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:

Dr. Donald R. Trippeer, CPA [email protected]

SUNY Oneonta

Vol 01 chapter 12 2015

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Transcript of Vol 01 chapter 12 2015