Don't let the AMT tax you by surprise
The alternative minimum tax (AMT) is perhaps the most unpleasant surprise lurking in the tax code. It was originally conceived to ensure all taxpayers paid at least some tax, but has long since outgrown its intended use.
The AMT is essentially a separate tax system with its own set of rules. How do you know if you will be subjected to the AMT? Each year you must calculate your tax liability under the regular income tax system and the AMT, and then pay the higher amount.
The AMT is made up of two tax brackets, with a top rate of 28 percent. Many deductions and credits are not allowed under the AMT, so taxpayers with substantial deductions that are reduced or not allowed under the AMT are the ones stuck paying. Common AMT triggers include:
- state and local income and sales taxes, especially in high-tax states;
- real estate or personal property taxes;
- investment advisory fees;
- employee business expenses;
- incentive stock options;
- interest on a home equity loan not used to build or improve your residence;
- tax-exempt interest on certain private activity bonds; and
- accelerated depreciation adjustments and related gain or loss differences on disposition.
The AMT includes a large exemption, but this exemption phases out at high-income levels. And unlike the regular tax system, the AMT isn’t adjusted regularly for inflation. Instead, Congress must legislate any adjustments. Congress has been doing this on an approximately year-by-year basis for several years, and they have already made an adjustment for 2009. But it’s important to remember that so far, Congress has only increased the exemption amount with each year’s “patch,” while the phaseout of the exemption and the AMT tax brackets remain unchanged. (See chart 3.)
Proper planning can help you mitigate, or even eliminate, the impact of the AMT. The first step is to work with Grant Thornton to determine whether you could be subject to the AMT this year or in the future. In years you’ll be subject to the AMT, you want to defer deductions that are erased by the AMT and possibly accelerate income to take advantage of the lower AMT rate. (See Tax planning opportunity 4 on zeroing out your AMT.)
Capital gains and qualified dividends deserve special consideration for the AMT. They are taxed at the same 15-percent rate either under the AMT or regular tax structure, but the additional income they generate can reduce your AMT exemption and result in a higher AMT bill. So consider your AMT implications before selling any stock that could generate a large gain.
If you have to pay the AMT, you may be able to take advantage of an AMT credit that has become more generous recently. You can qualify for the AMT credit by paying AMT on timing items like depreciation adjustments, passive activity adjustments and incentive stock options. The credit can be taken against regular tax in future years, as it is meant to account for timing differences that reverse in the future.
The AMT credit may only provide partial relief, but just got a little more generous. A tax bill enacted late in 2008 now allows you to use AMT credits at least four years old in 50-percent increments over a period of two years, even in years when the AMT continues to apply. The AGI phaseout of this special tax break has also been removed.
