Alternative Minimum Tax Planning
The Tax Reform Act of 1986 changed the tax landscape in many ways. One of the most significant changes was the creation of the Alternative Minimum Tax (AMT) regime which is a tax system parallel to the regular income tax system. Congress enacted a separate tax regime intending to achieve a high number of goals – not the least of which was to make sure that high income taxpayers paid their fair share of taxes. Using AMT, Congress has managed to extract taxes from many taxpayers who had modest income and modest taxes. New AMT taxes had the ancillary effect of additional tax burdens for many middle income taxpayers. Congress added a level of complexity to the tax laws that tend to be beyond the grasp of most all taxpayers and many tax practitioners. To the layman, the AMT rules defy comprehension. There are, however, a number of planning techniques available to taxpayers to minimize the harsh effect of the alternative minimum tax.
At the heart of the AMT system lie AMT adjustments and AMT preferences (IRC Sections 56, 57 and 58). These items generally increase alternative minimum taxable income resulting in taxing financial/tax events that Congress considered potentially abusive (read: transactions that reduce regular income tax liabilities).
In the opinion of this office tax return preparation software currently available to the consumer (non-professional) market does not give a taxpayer bullet proof computations to correctly determine AMT liability on Form 1040 filings. There are software weaknesses, but more importantly, it is the data input/interpretation by the user: tax data added to and subtracted from the AMT preference and adjustment items. We see many inaccuracies on self-prepared returns.
Below is a list of the major adjustments and preferences which an individual, filing Form 6251 (Alternative Minimum Tax), must consider in determining alternative minimum taxable income.
- Sale of stock obtained through an employer incentive stock option
- Passive activity losses: IRC§469
- Tax shelter farm losses may not be deductible for AMT
- Certain itemized deductions, e.g., state and local taxes
- Post-1986 depreciation adjustments
- Differences in AMT gain or losses on Real Estate Investment Trust
- Mining exploration and developmental costs
- AMT net operating losses
- Certain installment agreement losses
- Research and experimental expenditures
- AMT gain or loss versus regular taxes on the reporting disposition of
Property on Schedule D
- Exercise of incentive stock options create AMT taxable income
- Oil and gas well depletion costs
- Intangible drilling costs
- One half of the gain excluded from gross income under IRC Section
- 1202 on the sale of certain small business stock
Determining the amount of the taxpayer’s alternative minimum taxable income is a complicated matter. Like regular income taxes, AMT taxable income has an allowable exemption (2015: $83,400 for married taxpayers, $53,600 for single taxpayers). But, similar to the regular income tax regime, the AMT exemption is phased out over certain income levels (2015: phase out begins at $158,900 for married couples). High income joint filing taxpayers end up losing their entire exemption for AMT tax purposes upon reaching AMT taxable income of $492,500.
ALTERNATIVE MINIMUM TAX CREDITS
A little understood section of the alternative minimum tax system is a taxpayer’s ability to recapture alternative minimum taxes previously paid. Despite its name, the minimum tax credit (MTC) historically could only be used to offset a taxpayer’s regular income tax liability; it could not be used to reduce a taxpayer’s current alternative minimum tax liability. The MTC was designed to reimburse a taxpayer for tax that is “prepaid taxes” because of AMT. Historically, once AMT taxes were paid, an AMT credit would be available to offset a subsequent regular income tax liabilities – but not AMT taxes which continued to show up on many taxpayer filing.
Now the AMT tax credit can be used more broadly: non-refundable AMT tax credits are allowed in full against the taxpayer’s regular income tax and AMT tax liabilities. It is this tax practitioner’s view that the vast majority of tax professionals do not understand those instances in which a taxpayer can recapture prior AMT taxes paid.
When Congress enacted the Tax Reform Act of 1986, it recognized that some of the alternative minimum tax (AMT) preference items “reflected deferral, rather than the permanent avoidance of tax liability”. See Senate Report 99-313. 99th Congress, Second Session 521. Pay AMT in an early year and have an income tax liability later subject to an AMT credit.
This theory of only one tax did not always work because AMT continued to show up on a taxpayer’s subsequent returns. AMT taxes paid because of high itemized deductions meant no availability of the AMT tax credit. Itemized deductions for state income taxes paid were viewed as a permanent type of tax avoidance and therefore resulted in AMT liabilities.
AMT created and paid because of deferral preference items result in minimum tax credit (MTC) which in later years will be utilized against the regular income tax liability. AMT based upon adjustments (high itemized deductions) did not historically create AMT credits. AMT credit rules are extremely complex and require careful planning. Without careful planning, taxpayers can and do lose the benefits of minimum tax credits.
Congress under pressure from advocacy groups in recent years, has added patches to the alternative minimum tax laws – mostly in increasing AMT exemption amounts by modest amounts. All things considered these patches have done little to relieve high and middle-income taxpayers from paying the alternative minimum tax. Straightforward transactions such as a large long term capital gain reporting in relation to the taxpayer’s other income still trigger the alternative minimum tax.
For years an alternative minimum tax credit was available but difficult to utilize. Finally in 2007, and again in 2008 and 2009, Congress made long sought after changes in the utilization of minimum tax credit carry forwards which had been unusable for years. The typical unfortunate taxpayer is an executive who had incentive stock options, exercised those options and created a huge minimum tax liability which was paid for in the tax year of exercise. In later years this taxpayer continued to run into AMT adjustments and AMT tax credit. This was changed for tax year 2013 and beyond (IRC §53). We now have AMT credits against AMT tax and for regular income tax.
Here is an example of the complex language for the AMT credit – “the long term unused minimum tax credit is a portion of the minimum tax credit determined under Code Section 53(b), that is, the excess of ANMT for all earlier tax years over the minimum tax credit for these years attributable to the ANMT for tax years before the third year immediately preceding the tax year”. Code Section 53(e)(3)(a).
The long and short of it is taxpayers who have AMT issues including unused alternative minimum tax credits from prior years should seek out the services of a knowledgeable tax professional. The challenge is to determine appropriate amounts that are currently refundable over and above the AMT offsets. In essence long term unused minimum tax credits are currently allowed to be claimed as offsets and even refunded over a period of years.
The AMT tax regime is not well understood by the Internal Revenue Service nor by tax practitioners. Taxpayers are increasingly finding themselves paying alternative minimum taxes and not understanding what caused AMT tax liabilities and the possibility of AMT credits. There are no generalized strategies for the alternative minimum tax.
There is no substitute for accurate tax projections on a multi-year basis. Only a tax professional competent in alternative minimum tax computations and the minimum tax credit can guide a client through the intricacies of the AMT maze.
Recent legislation has helped high income earners with the AMT tax offsets and even refunds of AMT tax credits. On the other hand, little has been done for the average AMT taxpayer. Congress has only given the typical AMT taxpayer modest inflation adjusted “patches”. Despite recent exemption patches more and more taxpayers are finding themselves paying AMT taxes in recent years. That trend is likely to continue for revenue reasons.