You Owe Alternative Minimum Tax (AMT) - What Now?
Thomson Reuters tax analyst offers five damage control tips for U.S. taxpayers to consider
“Now, more than ever, ‘ordinary’ taxpayers find themselves staring at their freshly prepared Form 1040 in disbelief that they’ve been inducted into the alternative minimum tax (AMT) ‘club’,” noted Robin Christian, senior tax analyst for Thomson Reuters. “AMT is a separate U.S. tax system similar to the regular U.S. system; however, it chips away a variety of tax breaks.”
What Drives AMT?
Essentially, taxpayers compute tax under each system, compare the two, and pay the higher amount. “Ironically, the lower tax rates taxpayers have enjoyed over the last decade, coupled with the fact that AMT brackets aren’t adjusted for inflation while regular tax brackets are, increases the chance ordinary taxpayers will get snared with AMT each and every year.” Christian further explains that chances are good that. taxpayers will pay AMT if they:
- Paid a large bill for state income and/or real estate taxes in 2011 and have a large family. Why? State and local taxes are not deductible for AMT, nor are personal exemptions ($3,700 per person for 2011).
- Had a big capital gain or received a lot of dividend income in 2011. Even though long-term capital gains and qualified dividends have preferential rates for AMT, too much of a good thing can eat into the taxpayer’s AMT exemption that would otherwise be available to offset ordinary income. This can result in the ordinary income actually being taxed at higher rates for AMT than it was for regular tax, thereby edging the taxpayer into AMT.
- Exercised highly appreciated incentive stock options during 2011. In most cases, the bargain element (the stock’s value at the time it was exercised less the amount paid for it) escapes immediate taxation—for regular tax purposes. However, it does not escape AMT.
What Can a Taxpayer Do When AMT Strikes?
Christian suggested the following five considerations that may reduce AMT:
- Pass along dependency exemptions to your ex-spouse. Since personal exemptions are not deductible for AMT, they are wasted if the taxpayer is in AMT. However, it may be possible to shift the deduction to an ex-spouse. Usually, the custodial parent is entitled to the dependency exemption for the kids. However, the custodial parent can give the noncustodial parent a written release (generally on Form 8332 [Release of Claim to Exemption for Child of Divorced or Separated Parents]) that allows the noncustodial parent to claim the deduction by attaching the form to his or her tax return. “Your ex might not be your first choice, but a little goodwill between spouses never hurts and this doesn’t cost you anything,” noted Christian.
- Check your state tax refund. If taxpayers received a state or local income tax refund during 2011 that was included in regular taxable income (on line 10 of Form 1040), they should be sure to deduct it in their AMT calculation.
- If you used the standard deduction, reconsider. The standard deduction is not allowed for AMT, while certain itemized deductions are — namely charitable contributions, qualified housing interest, and investment interest expense (to the extent of investment income). However, to claim these deductions for AMT, taxpayers must elect to itemize their deductions for regular tax. “So, if you are using AMT, it may pay to elect to itemize even if your standard deduction would be larger,” advised Christian.
- Take a second look at home equity loans. Such interest is not deductible for AMT. However, if the loan proceeds were used for legitimate business or investment purposes, a taxpayer may be able to classify the interest as business or investment interest, which is deductible for AMT.
- Capitalize interest and property taxes. If taxpayers invested in a piece of raw land or any other unimproved real property, they can elect to capitalize (rather than immediately deduct) related interest and property taxes to the basis in the property. “This defers the deduction until you dispose of the property, but it’s better than permanently losing the deduction because of AMT,” said Christian.
The AMT calculation can be complicated and require fine-tuning. Adjustments to reduce AMT often have an effect on other tax items, so it is wise to do “before and after” comparisons. The IRS provides a free online “Alternative Minimum Tax (AMT) Assistant” at http://www.irs.gov, under “Online Tools.”
Taxpayers should consult with a personal tax advisor before applying these or other tax strategies.
Up-to-date analyses of legislation and regulations affecting individual taxpayers are available for tax and accounting professionals on the industry-leading, award-winning Thomson Reuters Checkpoint research platform.
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