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5 Ways to Take the Bite Out of Alternative Minimum Tax (AMT)
Suggestions from a Tax Expert from the Tax & Accounting business of Thomson Reuters
She explains, “This is largely because the AMT exemption lacks the inflation adjustment mechanisms applicable to many regular tax deductions and exemptions. Additionally, because of a number of taxpayer-friendly tax acts over the last few years, regular tax rates for many middle income taxpayers are about the same as the AMT rates. For 2008, married filing joint taxpayers are in the 28% regular tax bracket when their taxable income is between $131,450 and $200,300 and then they’re in the 33% regular tax bracket until taxable income goes over $357,700. Compare that to the AMT rate of 26% on alternative minimum taxable income up to $175,000 and 28% above that amount, and it’s easy to see the how so many taxpayers get ‘caught’ in the AMT trap.”
“Currently, unsuspecting ‘ordinary Joe’ taxpayers with several kids and high state income or property tax bills are the most likely AMT victims. Throw in a large capital gain or the exercise of a few incentive stock options and there’s no escaping it. It’s plain to see that AMT is now actually more likely to burn middle-income types than the truly wealthy,” says Christian.
Background: AMT is a type of tax that runs parallel to the regular tax. First, you calculate your regular income tax based on regular taxable income. Next, you add back certain deductions and “preference items” to your regular taxable income to calculate AMT. In the end, you pay the higher of the two taxes.
Says Christian, “When AMT strikes, you lose the benefit of many traditional tax breaks, including personal exemptions; state and local income, property, and sales tax deductions; home equity loan interest expense deduction (unless the loan proceeds were used for home improvements); and, for those who don’t itemize, the standard deduction - just to name a few.”
Do’s and Don’ts for AMT Planning from Thomson Reuters
According to Christian, it’s unfortunate that it is so difficult to “plan around” the AMT. Tax laws were cleverly drafted to prevent moves that are effective in reducing regular income taxes from also reducing AMT liability. This means that many traditional planning strategies don’t work for AMT; in fact, many may backfire. But here are a few “dos and don’ts,” that can lessen the effect of the AMT:
1. Do take action to reduce your adjusted gross income (AGI) for 2008. A lower AGI makes it more likely that you’ll be able to claim your full AMT exemption, or at least a bigger part of it. A lower AGI will also reduce your state and local income tax bills, which will further reduce your AMT exposure. Finally, a lower AGI may also qualify you for any number of other breaks that will reduce both the regular tax and AMT liabilities. How can you do this? The most common techniques are using income or deductions that you can easily control. For example, cash-basis sole proprietors and farmers might delay year-end billings so that they fall in the following year and/or accelerate payment of certain expenses, such as office supplies and repairs and maintenance to 2008. On the investment side, income from short-term (i.e., maturity of one year or less) obligations like Treasury Bills and short-term CDs is not recognized until maturity. Income from those investments straddling year-end should be deferred to the following year. For sales of property, consider an installment sale that shifts part of the gain to later years when the installment payments are received. You might also be able to unload a bad investment or two before year-end, triggering deductible capital losses of up to $3,000 for 2008. “Since there are so many ways to try to minimize AGI, what works for you will depend on your individual tax and financial situation. Many people are being shifted just due to lay-offs. In any case, shifting income is one area where competent tax advice can be instrumental,” says Christian.
2. Don’t prepay state and local income or property taxes that would otherwise be due and deductible in 2009. Prepayment may generate a bigger regular tax write-off for 2008, but the deduction is completely disallowed in computing AMT. So, prepaying in 2008 could turn an expense that could otherwise be deducted in 2009 into an expense that will never generate any tax benefit whatsoever.
3. Do pay your January 2009 home mortgage payment and any planned 2009 charitable donations in 2008 instead of waiting until 2009. These items are deductible for both AMT and regular tax, so paying them in 2008 will cut your 2008 AMT tax bill. This is true even if your itemized deductions don’t exceed you standard deduction for 2008. However, as you have to use the same method for regular tax and AMT, it is imperative that you elect to itemize deductions by completing Schedule A when you file your Form 1040. Also, prepayment will work for interest on home equity loans only if the loan proceeds were used to buy, build, or substantially improve your home—otherwise the interest isn’t deductible for AMT.
4. Don’t buy tax-free municipal bonds that fall into the private activity bond category (such as bonds issued to finance sports facilities). Interest on these bonds is tax-free under the regular tax system, but is taxable under AMT.
5. Do think twice before using home equity loan proceeds to pay off debts that generate nondeductible personal interest (for example, to pay off credit card balances). Interest on such loans is deductible for regular taxes, but not for AMT. Of course, you may still come out ahead economically by taking out a low-interest home equity loan to pay off high-interest debts. There just won’t be any tax savings. Also, interest on home equity loans used to buy, build, or substantially improve your home is deductible for both AMT and regular taxes. So, those loans are okay.
Christian urges folks to take a fresh look at their tax planning options, now rather than later. Some well planned maneuvers before year end can go along way in taking the bite out of AMT come April 15, 2009.
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