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14Alternative Minimum Tax Presented by: Kathryn M. Keane, EA

Alternative Minimum Tax Overview/Objectives It was 1969 when the government realized that 155 high income individuals legally paid very little or no tax, thanks to the use of permitted tax deductions. Since then, Alternative Minimum Tax has haunted taxpayers and their returns. In 1997, approximately 618,000 taxpayers filed Form 6251, up from 132,000 in the tax year 1990. According to IRS 2010 Fall Statistics on Income Bulletin1, over 3.9 million taxpayers were impacted by AMT in tax year 2008. For the tax year 2011, the taxpolicycenter.org estimated 4.3 million taxpayers were impacted by the AMT and $ 39.1 billion in revenue was received either directly or indirectly due to the AMT. After this session, attendees will be able to:

Calculate common adjustments for AMT Be aware of less common AMT adjustments Calculate AMT using Form 6251 with a comprehensive problem Offer ideas and options to clients impacted by AMT

What is Alternative Minimum Tax (AMT)? Created in 1969 in response to news of high-income taxpayers avoiding federal income tax, the AMT is in essence a parallel tax system which adjusts or invalidates certain tax positions and deductions once perceived as preferential. Back in 1969, the AMT triggers were only seen on high income taxpayers. Since the AMT has never been truly adjusted for inflation, the average professional taxpayer comes dangerously close to AMT liability. The New Year’s Day Tax Bill did bring indexing for inflation to the AMT exemption amount which ends the Annual AMT Patch Dance. Calculating Alternative Minimum Taxable Income (AMTI) Form 1040 filers begin with income after itemized deductions. Standard Deduction filers begin with their income after Adjustments but before applying the Standard Deduction. Adjustments are made to entries on Form 1040 to conform to AMT rules.

                                                            1 IRS 2010 Fall Statistics on Income Bulletin, at http://www.irs.gov/pub/irs‐soi/10fallbul.pdf 

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The function of Form 6251, Alternative Minimum Tax, is to bridge the regular tax laws and the allowed deductions and income differences under AMT rules. Entries on Form 6251 are actually the adjustments between both tax worlds. AMT Adjustments Medical expenses are limited by 10% of Adjusted Gross Income for the AMT calculation. This exclusion adjustment is the lesser of the Schedule A deduction or 2.5% of the AGI. This adjustment should be handled by tax software. As the Health Care Reform comes into effect, this deduction will be obsolete in 2013 (for taxpayers under 65 years of age) as the floor for the medical expenses on Schedule A will move to 10% of AGI.

Example: Iggy’s AGI is $ 79,000. His medical expenses are $ 6,400. For regular tax, his medical expense deduction is $ 475 (Medical Expenses of $ 6,400 reduced by 7.5% of her AGI <$ 5,925>). For AMT, Iggy’s adjustment is the lesser of the deduction ($ 475) or 2.5% of his AGI ($ 1,975). Therefore, Iggy would enter $ 475 on the appropriate line of his Form 6251.

When taxpayers fall into AMT and have medical expenses in excess of the AGI floor, they should review the potential of Flexible Spending Accounts or other pre-tax health plans. Taxes deducted from Schedule A include all taxes deducted on Schedule A. When taxpayers face AMT, they may benefit from adjusting withholding to avoid over-withholding as well as different timing of other taxes such as real estate taxes. Other strategies may include:

Real estate taxes on unproductive and unimproved land may be capitalized. By electing to capitalize the real estate tax and not deducting it, the real estate tax is added to the basis of the property. (see Reg 1.266-1(b)(1)(i) and Reg 1.266-2(i)

Revisit allocations of taxes deducted on income schedules, such as Schedule E or Form 8829. Business use percentages or square footage usage may change over time and not necessarily be uncovered in tax interviews.

Home mortgage interest deduction must be adjusted for any home equity loans or refinancing that resulted in “new money”. For AMT, only acquisition debt is allowed.

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Acquisition debt is debt, secured by the home, to buy, to build, and/or to improve. When a taxpayer refinances a qualified home mortgage and does not increase the face of the mortgage, no adjustment is required. It is essential when classifying home mortgage interest that the “tax definitions” are used.

Example: Iggy paid $ 2,995 in mortgage interest to Bank A. The Form 1098 reports it as “Line of Credit”. After discussion, the preparer discovers that Iggy used the “Line of Credit” to cover the cost of supplies directly linked to the installation of a bowling alley in his basement/Man Cave. Because the mortgage interest, secured by the residence, was directly linked to an improvement/addition to his home, no AMT adjustment is required.

Example: Iggy also paid $ 3,995 in mortgage interest to Bank B. The Form 1098 reports it as “Line of Credit”. After discussion, the preparer discovers that Iggy used the “Line of Credit” to cover the cost of a trip to Bali. Because the mortgage interest, secured by the residence, was not used to buy, to build nor to improve his home, an AMT adjustment is required

When a taxpayer refinances and the refinance results in additional debt, the mortgage interest expense must be allocated among the acquisition portion and home equity portion.

Example: Clyde obtains a $ 100,000 mortgage on his residence using the bank’s Home Equity Loan Program. He used $ 80,000 to add a room to his home and $ 20,000 to pay down his credit card debt. Regardless of what the bank may call the loan product, for tax purposes, the loan is a mixed use mortgage. $ 80,000 of the debt is acquisition debt as it is used to build, to buy and/or to improve his home. The remaining $ 20,000 is home equity debt. Using the ratio of the home equity debt over the total debt ($ 20,000/$ 100,000), 20% of the mortgage interest is not permitted for AMT.

Miscellaneous Deductions are not permitted on Form 6251. While this adjustment should be handled easily by tax software, some tax planning may help impacted taxpayers. Some strategies to explore may include:

Encourage clients to negotiate for better reimbursement plans, especially accountable plans.

Revisit allocation of tax preparation fees for clients filing income schedules such as Schedule C, E or F. The portion of the tax preparation fee directly linked to

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the activity and not the return in full can be deducted as a business (or rental) expense.

Tax refunds reported on Form 1040 are not income for AMT and therefore subtracted. Investment Interest Expense is limited in ordinary tax by the net investment income reportable on page one of Form 1040. Since AMT includes other forms of income (i.e. Private Activity Bonds), recalculate the investment interest expense deduction for AMT. Prepare a second Form 4952, Investment Interest Expense Deduction, using AMT rules and clearly labeling the form as “AMT Purposes Only”. Other adjustments to the AMT Form 4952 may include:

Differences in gain/loss due to differences in basis between AMT and regular (or ordinary) tax

Investment Expenses as AMT disallows Miscellaneous Deductions claimed on Schedule A, the usual place to deduct such expenses. Therefore, no adjustment for Investment Expenses is required for AMT.

Example: Iggy had $1000 in regular bank interest and $ 295 in Private Activity Bonds which are subject to AMT. He also paid $ 1,350 in investment interest as well as $1,350 in investment expenses of which $ 320 were deductible on his Schedule A. (See end of module for Iggy’s 1040, Sch A, 6251.) Below is his 4952 for Regular tax and his AMT 4952.

Iggy’s Regular 4952

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Iggy’s Form 4952 for AMT Purposes

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Iggy’s adjustment for Form 6251 is computed as follows: Regular 4952 $ 680 less the AMT allowable deduction of $ 1295 = Form 6251 adjustment of ($615), which Is entered on the appropriate line.

Software Alert! Does your software compute the AMT version of Form 4952 correctly? Many require manual adjustments for the investment expense, addition of the PAB Interest. Be alert!

Depletion must be recalculated to conform to AMT rules, using only income and deductions allowed. Adjust the AMT basis of the activity for the AMT depletion. Enter on Form 6251, Alternative Minimum Tax-Individuals, the difference between the depletion claimed and AMT allowable depletion.

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Net Operating Losses must be recalculated entirely for AMT, using only income and deductions allowed for AMT. The regular tax NOL is “added back” on one line while the permitted NOL deducted (ATNOLD) is entered on another line. For AMT, use whatever carry-back/carry-forward option utilized for regular tax. Because the makeup of the original NOL will differ for AMT, the application will be different as well. The Member’s Only section of the NATP website (www.natptax.com) contains an extraordinary worksheet for calculating the ATNOLD. Copies of these worksheets can be found at the end of this module. Interest from Private Activity Bonds are less elusive as they once were with the advent of the revised Form 1099 INT. Generally, these bonds were issued between August 7, 1986 and before 2009 and were not included in gross income for regular tax. The interest income from these bonds is included for AMT.

Example: Iggy, our on-going AMT victim, had $ 295 in Private Activity Bond (affectionately known as PAB). This income is not taxable for Regular tax (1040) but is income for AMT. Iggy will include the $ 295 on the appropriate line of his 6251. He will also include this number if he has any other income linked item subject to AMT, such as the MAGI calculation for Passive Loss Limitations.

Qualified Small Business Stock sold at a gain could be excluded under Section 1202 if held for more than five (5) years. For AMT. multiply the excluded gain by seven percent (7%) and enter as a positive number on Form 6251. Exercise of Incentive Stock Options usually does not result in taxable income for regular tax. For AMT, report the excess, if any, of the fair market value of the stock acquired through exercise of the option when the option becomes transferable or when no substantial risk of forfeiture applies over the amount paid for the stock.

Example: Iggy’s employer issued an ISO with an exercise price of $4.50 per share that would be immediately transferable and carried no risk of forfeiture. The FMV of their stock on that date was $15 per share. Below is Iggy’s Form 3921, Exercise of an Incentive Stock Option Under Section 422 (b).

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Iggy’s adjustment is $42,000 for his AMT. The adjustment is the excess of the FMV (4,000 x $15.00 = $60,000) over his cost (4,000 x $ 4.50 = 18,000). When Iggy’s sells the stock, his basis for regular tax is $ 18,000 and for AMT $ 60,000.

This adjustment will lead to a Minimum Tax Credit because it is a deferral adjustment and not a permanent or exclusion adjustment. Disposition of Property adjustment occurs when there is a difference in the basis of an asset disposed.

Example: Iggy from the above example sells his stock in Jan of 2013 for $ 30 per share. For regular tax, Iggy has a short term gain of $ 25.50 per share ($ 30 less his regular tax basis of $ 4.50) or a total of $ 102,000. For AMT. Iggy has a gain of $ 15 per share ($ 30 less his AMT basis of $ 15 per share) for a total AMT gain of $ 60,000. His AMT adjustment is ($ 42,000), computed the difference between his regular gain of $ 102,000 and his AMT gain of $ 60,000). Remember, Form 6251 bridges the two tax worlds and reflects the difference between them.

The same adjustment applies with any asset that has a different basis for AMT. Most common differences in basis result from depreciation and depletion adjustments.

Example: Frankie purchased equipment for his Schedule C business on Jan 1,

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TY1 at a cost of $ 25,000 with a MACRS class life of 7 years and an ADS class life of 12 years. For regular tax, he claimed $3,571 in regular MACRS depreciation and $ 1,997 in ADS depreciation. On December 30, TY2, Frankie sold the equipment for $ 18,154 and had expenses of sale of $ 1,000. For TY2, he claimed the usual depreciation for the equipment. Below are both Forms 4797, Sales of Business Property. The column e entry reflects the total of depreciation allowed for regular tax and AMT respectively.

For regular tax, Frankie’s Form 4797:

For AMT calculations, Frankie’s Form 4797:

Frankie’s AMT adjustment on the disposition will be a negative adjustment of $ 1,574, calculated as the difference between the regular tax gain of $ 1,214 and the AMT gain of $ 2,788. Post 1986 Depreciation adjustments do not include those adjustments reported elsewhere on Form 6251, such as Passive Losses. In addition, the depreciation adjustment does not include residential rental property placed in service after 1998, nonresidential real property placed in service after 1998 with a class life of 27.5 years or more using straight line method for regular tax purposes, Section 1250 property placed in service after 1998 using straight line method for regular tax purposes, Section 179

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expense deductions, bonus depreciation and depreciation computed using ADS method or unit-of-production method.

Example: Gina purchased a computer for her Schedule C retail activity. Her business use of this computer is 100%. With a cost of $995, her MACRS deduction for the first year is $ 199. For AMT, use the ADS method and ADS class life. Gina’s AMT depreciation is $ 149. Her adjustment on her Form 6251 is $ 50.

Passive Activities are recomputed using income and losses allowed for AMT. AMT impacts Passive Activities most commonly because of depreciation adjustments. It is common for a rental return to have a different basis in assets as well as in suspended losses due to those AMT items. For Form 8582 used for AMT purposes, Modified Adjusted Gross Income (MAGI) is recalculated using AMT adjustments.

Example: Lauren had current depreciation for ordinary tax purposes of $ 13,635 and AMT depreciation of $ 9,272. In addition, her suspended losses for AMT purposes were $ 44,729. In Lauren’s case, the differences between ordinary tax and AMT do not change the $ 25,000 Special Allowance, but the suspended losses brought into the current year were different and the suspended loss carried in to the future is different

Lauren’s 8252 Worksheet 1 for AMT Purposes follows:

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Lauren’s 8582 for AMT Purposes follows:

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Lauren’s Worksheet 4 for AMT Purposes calculates the loss suspended and carried into future years. Worksheet 4 for AMT Purposes follows:

Example : AMT impact on calculation of MAGI, Current Year Special Allowance and Suspended Losses For ordinary tax purposes, Sheila’s income includes:

$125,000 in wages and

$ 5,000 in taxable interest and $6,548 in Private Activity Bonds subject to AMT.

o She owns two active participation rental properties. Her current year rental loss is $20,367. Her suspended losses are $ 9,841.

Her Schedule A, Itemized Deductions, reflects total taxes paid on line 9 of $24,574.

For ordinary tax purposes, her MAGI is $ 130,000 and her Special Allowance is $ 10,000.

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Sheila’s 8582 for ordinary tax purposes follows:

For AMT purposes, Sheila’s suspended loss carried into the current year was $ 9,129. Sheila’s AMT-MAGI includes the Private Activity Bond Interest of $ 6,548. Since her AMT-MAGI is different than her MAGI, we use Part II of 8582 to compute the Special Allowance for AMT.

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Sheila’s 8582 for AMT follows:

Sheila’s Special Allowance for Rental Real Estate, for AMT purposes, is $ 6,726. Use another Worksheet 1 to net the income and loss for each property, recalculating for all AMT adjustments. Sheila’s Worksheet 1 for AMT follows:

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Use Worksheet 4 for AMT purposes to allocate the Special Allowance among the activities. Sheila’s Worksheet 4 for AMT follows:

Use Worksheet 5 for AMT purposes to calculate the suspended losses for AMT use that we will carry into future years. Sheila’s Worksheet 5 for AMT purposes follows:

As with regular tax, losses from Publicly Traded Partnerships (PTP) can not be used to offset other income. For AMT, the losses from PTP must be recomputed using AMT income and deductions. Loss Limitations does not include losses addressed in other sectors of Form 6251 such as Passive Activities. This sector is utilized for adjustments to gains and losses from pass through entities not impacted by the Passive Loss Limitation rules. Losses are recomputed reflecting AMT rules. The difference between the loss for regular tax and the AMT allowed loss is the adjustment. Circulation Costs are expenditures to establish, maintain or increase the circulation of a newspaper, magazine, or other periodical. For AMT, any circulation costs deducted in full for regular tax must be capitalized and amortized over 3 years. The difference between the deduction claimed and the AMT amortization is the adjustment. When assets linked to such deductions are sold or disposed of, there will be a basis difference for AMT.

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Long Term Contracts adjustment reflects the adjustment for income reported on long term contracts. For AMT, the percentage of completion method must be used to determine the amount of income to “report”. The adjustment is the difference between the AMT percentage of completion method and the income actually reported on Form 1040. Mining Costs include mining exploration and development costs that for regular tax are usually deducted in full. For AMT, these costs must be capitalized and amortized over ten (10) years. The AMT adjustment is the difference between the amount deducted on Form 1040 and the AMT amortization. Research and Experimental Costs that are deducted in full for regular tax must be capitalized and amortized over ten (10) years. The AMT adjustment is the difference between the amount deducted on Form 1040 and the AMT amortization. Installment Sales of non-dealer dispositions of property after August 16, 1986 and before January 1, 1987 were not recognized as Installment Sales reporting method for AMT. Intangible Drilling Costs from oil, gas, and geothermal wells are an AMT preference item to the extent that the IDC costs exceed 65& of the net income from the wells. Comprehensive Problem Iggy Schwartzenheimer is a single taxpayer with W-2 income of $ 78,000, ordinary interest of $ 1,000 and private activity bond interest of $ 295. His Schedule A contains the following:

Medical Expenses $ 6,400 Investment Interest Paid

$ 1,350

State/Local Income Taxes $ 6,000 Professional Association Dues

$ 275

Real Estate Taxes $ 4,511 Tax Preparation $ 250

Mortgage Interest (Acquisition)

$ 2,995 Investment Interest Paid

$ 1,350

Mortgage Interest (Home Equity)

$ 3,995 Investment Expenses $ 1,375

:

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The interesting parts of Iggy’s return follow:

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What strategies could be offered to taxpayers?

Dependents o If any of the children were from prior relationships, if may be beneficial for

them to give the exemption to the non-custodial parent, or not

Standard Deduction vs. Itemized Deductions o In some cases, it may be beneficial for itemizers to take the standard and

for standard deduction filers to itemize

Mortgage Interest o It may be beneficial for the taxpayer to accelerate payments on their home

equity debt, or not

Any other ideas? As with all tax planning, what is good for the goose may not be good for the gander. Each situation must be fully explored with special attention to state tax impact.

Minimum Tax Credit

An Overview of the Alternative Minimum Tax

No effective discussion can be held on the Minimum Tax Credit that does not begin with a look at the Alternative Minimum Tax (Form 6251). Essentially a parallel tax system, the Alternative Minimum Tax (AMT) hovers over all individual tax returns, adjusting and disallowing deductions. The Form 6251 in effect serves as the bridge between the AMT world and the 1040 world, reporting the differences between these two tax worlds. In the AMT world, there are two adjustments: Exclusions and Deferrals.

Exclusions: Also known as Exclusion Preference Items are items that are permanent differences between the 1040 and the AMT. These items are never permitted to be deducted in the AMT world. Common examples of Exclusions are:

Standard Deduction

Personal exemptions

Excess Depletion

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Tax-Exempt interest from private activity bonds issued after August 7, 1986 (For tax year 2009 and 2010, these items were not considered as Exclusions, but we include it when computing the 2011 Form 8801)

Certain Itemized Deductions

o Taxes

o Miscellaneous Deductions subject to the 2% of AGI reduction

o Medical (the smaller of 2.5% of AGI or the deductible medical expenses)

Deferral Items: Also known as timing differences, Deferral items are items treated differently in the AMT world than in the 1040 world. The most commonly known deferral item is the Incentive Stock Options (ISO). In the 1040 world, the ISO is not taxable when exercised but is included when sold. In the AMT world, the ISO is recognized and “taxable” when exercised. This results in an adjustment in basis on the sale as well as creates an AMT liability in most cases. Another common deferral item is depreciation. For AMT purposes, certain depreciation systems are not used. The differences between the two depreciation deductions are deferral or timing differences.

The Minimum Tax Credit is allowed only for the AMT caused by Deferral Items.

Example: For tax year 2011, Harry deducted his State and Local Income Taxes, Real Estates and Job Expenses. He had no other AMT items on his tax return. His 2010 AMT was $ 3,214. Because he has only Exclusion Items, he has no Minimum Tax Credit for his 2010 AMT to calculate for tax year 2012.

Example: For tax year 2011, Albert claimed depreciation and reported the sale of a business asset with an AMT adjustment. Because Albert had deferral items on his 2010 Form 6251, he may have a MTC for tax year 2012.

Calculating the MTC

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Generally, the Minimum Tax Credit is the amount of the AMT actually paid less the amount of AMT calculated if only Exclusion Items were considered. While this “rule of thumb” is a effective tool to watch for when the MTC may be available, use of the Form 8801 is required.

Think about Iggy from the earlier portion of this module. Since he actually had an AMT liability and he had Deferral Items (the ISO), Form 8801 should be completed. To accurately complete Form 8801, Form 6251 must be prepared, even if it results in no AMT liability. The credit is carried until Iggy has no AMT liability. In that year, the credit is available for use. For tax years prior to 2013, it is possible for some taxpayers to have a refundable portion.

The unused MTC can be carried forward indefinitely. It is not subject to a carry back.

Software Tip: Many software packages carry the 6251 information from the prior year without much supervision. However, 8801 carry forward is a topic that many tax professionals voice concern over. Take the time and review the entries!

Refundable Minimum Tax Credit

For tax years beginning after December 20, 2006 and before January 1, 2013, a portion of the MTC is refundable. Part IV of Form 8801 is used to calculate the tentative refundable credit.

The refundable MTC is the greater of:

50% of the long-term unused MTC or

The prior year AMT refundable credit.

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The long-term unused MTC is the MTC applicable to tax years three years prior to the present tax year. For tax year 2012, long-term MTC is the MTC attributable to 2009 and earlier years. When using the long-term unused MTC, consider the oldest MTC used first. The refundable MTC can offset regular tax and AMT, and is refundable to the extent it exceeds the taxpayer’s tax liability for the year, after applying any MTC available before considering the refundable amount.

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