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 Alternative Minimum Tax is nothing new; in fact it first appeared on tax forms dating back to 1978. The problem is that more and more individuals are falling victim to the alternative minimum tax and don't completely understand its purpose. There are even some ways to create a tax shelter and avoid paying a minimum tax, and we will discuss some strategies later in this article.
Alternative Minimum Tax Rules
The IRS's tax code gives special treatment to certain kinds of income and allows taxpayers to take tax deductions or credits for other special expenses. Unfortunately, if you are qualified to take too many of these exemptions or tax credits, your tax liability may fall below a threshold and the alternative minimum tax kicks in. This tax ensures that people that benefit too much from these special provisions are paying their fair share, or a minimum tax.
When that happens, the taxpayer is directed to a special form that figures your tax liability using a different formula than the normal tax calculation. Essentially, you wind up adding back certain tax deductions you may have taken to your income. Once you've gone through the alternative minimum tax calculation, you will pay the higher of your "normal" tax liability or the minimum tax.
The intention of the alternative minimum tax, or AMT, is to set a minimum tax rate of around 27% for some of the highest earning taxpayers in the United States. The AMT prevents these individuals from taking advantage of tax loopholes which allow them to shelter a substantial amount of income from federal income taxes. The AMT eliminates some of the benefits of what are called tax preference items including:
- Accelerated depreciation rates
- Long-term capital gains
- Percentage depletion
- Tax exempt income
- Tax credits
Unless changed by Congress, by 2010, an estimated one in five taxpayers will have an AMT liability. This problem stems from a lack of indexing for inflation and is widely viewed as a flaw in the alternative minimum tax rule's initial design. In 2006, an estimated 3.8 million taxpayers are expected to be affected by the Alternative Minimum Tax. And by 2007, that number is expected to grow to 23 million taxpayers.
Recent Changes to the AMT
For the 2007 tax year, if you made over $75,000, then you should run through IRS form 6251 to make sure you are not subject to the minimum tax. In addition, if your taxable income for normal tax purposes plus any adjustments and preference items that apply are more than the exemption amount, then you may have to pay the alternative minimum tax.
The 2007 AMT exemption amounts include:
- If your filing status is married filing jointly or are a qualifying widow or widower jointly then the exemption amount is $45,000.
- If your filing status is single or head of household then the exemption amount is $33,750.
- If your filing status is married filing separately, then the exemption amount is $22,500.
Some of the adjustments and tax preference items include: certain itemized deductions, taxable state and local tax refunds, accelerated depreciation of certain property, certain tax exempt interest and the difference between the alternative minimum tax and a regular tax gain or loss on the sale of property, treatment of incentive stock options and depletion allowances.
For more complete instructions, see the information contained in IRS Form 6251.
AMT Calculations
In addition to running through your normal, or standard, income tax calculations, the alternative minimum tax uses a second set of rules for determining taxable income as described in IRS publication 6251. The outcome of those calculations is what's called a Tentative Minimum Tax, or TMT, which is then compared to the income taxes owed via the "standard" method.
If this standard income tax owed is greater than the calculated TMT, then the taxpayer owes income taxes based on the standard method. However, if the Tentative Minimum Tax is greater than the standard tax calculation, then the difference between the TMT and the standard method is added to the taxpayers "normal" tax liability. This total amount is the amount owed and referred to as the alternative minimum tax.
Sheltering from the Alternative Minimum Tax
If you are looking to shelter yourself from this tax, then your strategy should be to accelerate your income and defer deductions you may have taken.
Some of the ways you can accelerate income include:
- Withdrawing money from a taxable IRA or 401k plan.
- Cashing in any US Savings bonds - Series EE - that you may be holding.
- Taking a short-term capital gain on a stock position you are holding.
- Switching from tax-free bond holdings to taxable bonds.
- Closing out a certificate of deposit to take the interest income gain.
If you are running a business, you can defer deductions by depreciating capital expenditures such as the purchase of office equipment instead of expensing the cost in the current year.
Finally, you can delay the payment of certain deductible items to reduce the risk of paying the alternative minimum tax. For example, in December 2007 you may have prepaid real estate taxes that are due in January 2008. This strategy allows you to take the tax deduction in 2007, which lowers your tax liability, but may trigger a minimum tax. You can also apply this same strategy to medical expenses and un-reimbursed business expenses.
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