The Alternative Minimum Tax was permanently extended this year by the American Taxpayer Relief Act of 2012 after a decade of legislative patches. Passed in the first days of 2013, it retroactively applies to the 2012 tax year.
Here’s a quick guide to understanding the current rules.
The AMT is essentially a separate federal income tax system with its own tax rates, and its own set of rules governing the recognition and timing of income and expenses.
If you’re subject to it, you have to calculate your taxes twice – once under the regular tax system and again under the AMT system. If your income tax liability under the alternative is greater than your liability under the regular tax system, the difference is reported as an additional tax on your federal income tax return. If you’re subject to the AMT in one year, you may be entitled to a credit that can be applied against regular tax liability in future years.
Part of the problem with the AMT is that, without doing some calculations, there’s no easy way to determine whether or not you’re subject to the tax. Key “triggers” include the number of personal exemptions you claim, your miscellaneous itemized deductions, and your state and local tax deductions. So, for example, if you have a large family and live in a high-tax state, there’s a good possibility you might have to contend with the tax. IRS Form 1040 instructions include a worksheet that may help you determine whether you’re subject to the it (an electronic version of this worksheet is also available on the IRS website), but you might need to complete IRS Form 6251 to know completely.
It’s no easy task to calculate the AMT, in part because of the number and seemingly disparate nature of the adjustments that need to be made. Some of the more common adjustments are as follows:
• The federal standard deduction, generally available under the regular tax system if you don’t itemize deductions, is not allowed for purposes of calculating the AMT. Nor can you take a deduction for personal exemptions.
• Under the AMT calculation, no deduction is allowed for state and local taxes paid, or for certain miscellaneous itemized deductions. Your deduction for medical expenses may also be reduced and you can only deduct qualifying residence interest to the extent the loan proceeds are used to purchase, construct or improve a principal residence.
• Under the regular tax system, tax is generally deferred until you sell the acquired stock. However, for AMT purposes, when you exercise an incentive stock option, this does cause a change in your AMT calculations and possibly your tax.
While the AMT takes away personal exemptions and a number of deductions, it provides other specific exemptions. The amount of AMT exemption that you’re entitled to depends on your filing status and your exemption amount and begins to phase out once your taxable income exceeds a certain threshold.
Under the AMT, the first $175,000 for 2012 of your taxable income is taxed at a rate of 26 percent. If your filing status is married filing separately, the 26 percent rate applies to your first $87,500 in taxable income. Taxable income above this amount is taxed at a flat rate of 28 percent.
Owing the alternative minimum tax isn’t the end of the world, but it can be a very unpleasant surprise. It also turns a number of traditional tax planning strategies – such as accelerating deductions – on their heads, so it’s a good idea to factor in the AMT before the end of the year, while there’s still time to plan.
If you think you might be subject to the AMT, it may be worth sitting down to discuss your situation with a tax professional.
Life is a journey, plan for it.
Neil A. Brown is a CPA and CFP with Burkett Financial Services in West Columbia. Reach him at www.uscneil.com or (803) 200-2272.