
[ Back ] We Can Help With Your Tax Problems! 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) 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 not previously paid taxes and to increase the tax burdens of many middle income taxpayers. Congress has added a level of complexity to the tax laws that is beyond the grasp of virtually all taxpayers and most tax practitioners. To the layman, the AMT rules defy comprehension. There are, however, a number of planning techniques available to sophisticated taxpayers to minimize the harsh effects 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 events that Congress considers potentially abusive (read: transactions that reduce regular income tax liability). In the opinion of this office tax return preparation software currently available on the consumer market does not give a taxpayer bullet proof computations to correctly determine AMT liability on their Form 1040. There are software weaknesses, but more importantly, it is the data input/interpretation as what is to be added and subtracted as preference items and/or AMT adjustment items which create most inaccuracies. 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. ADJUSTMENTS Sale of stock obtained through an employer incentive stock option plan Passive activity losses Tax shelter farm losses Certain itemized deductions, e.g., state and local taxes Post-1986 depreciation Mining exploration and development costs AMT net operating loss Certain installment sales Circulation and research and experimental expenditures PREFERENCES Exercise of incentive stock options 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 therefore a complicated matter. Like regular income taxes, AMT taxable income has an allowable exemption. But, similar to the regular income tax regime, the AMT exemption is phased out over certain income levels. High income taxpayers end up losing their exemptions for AMT tax purposes. 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 alternative minimum tax liability. The MTC was designed to reimburse a taxpayer for tax that is "prepaid" because of AMT. Thus, once AMT taxes are paid, a credit may be available to offset a subsequent regular income tax liability on the same transaction. 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 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. For example, AMT taxes paid because of high itemized deductions are not subject to recapture as an alternative minimum tax credit. Itemized deductions for state income taxes paid are viewed as a permanent type of tax avoidance and therefore resulting AMT liabilities do not create MTC credits. Other AMT preference such as the exercise of incentive stock options reflect deferral considerations rather than permanent avoidance, and therefore, AMT taxes paid on account of the exercise of incentive stock options can be recaptured in later years. The exercise of an incentive stock option creates an AMT preference in the year of exercise and will often result in alternative minimum taxes even though the taxpayer is only paying for and receiving stock and is not selling or receiving cash. AMT created and paid because of deferral preference items such as the exercise of incentive stock options will result in minimum tax credit (MTC) which in later years can be utilized against regular income tax liability. This MTC credit historically could be claimed in the year of the sale of ISO (AMT causing) stock in question or in a year of high regular income tax liability. These rules are extremely complex and require careful planning. Without an understanding of AMT and careful planning, taxpayers can and do lose the benefits of minimum tax credits. Congress, under pressure from taxpayer and 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 mid-income taxpayers from paying the alternative minimum tax. Simple things such as a large long term capital gain in relation to the taxpayer's other income still trigger the alternative minimum tax. Exercise of incentive stock options continue to bring unwary taxpayers into alternative minimum tax liability. For years an altlernative 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 was a Silicon Valley entrepreneur 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 saw the value of his stock fall. While the credits (MTC) were available they could not be used against ordinary income tax. This has now changed. For tax years beginning in 2007 we have had a refundable minimum tax credits. Not only will a minimum tax credit wipe out all ordinary income tax for a taxpayer but the credit is now refundable. Here is an example of the complex language for the 2008 AMT legislation - "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". This is Code Section 53(e)(3)(a). The long and the short of it is taxpayers who have unused alternative minimum tax credits from prior years should seek out the services of a knowledgeable tax professional to determine appropriate amounts that are currently refundable over and above the offsets to their ordinary income tax for a given year. In essence long term minimum tax credits are currently allowed to be claimed and refunded over a two year period. Also now available is a program for the abatement for interest and penalty assessments paid for pre 2008 alternative minimum tax liabilities assessed because of the exercise of incentive stock options. We can thank the 2008 TARP legislation for this dramatic change in the acceleration of the availability of AMT credit offsets to ordinary income and the acceleration of minimum tax refunds. The AMT 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 to rear its ugly head. 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. Conclusion: Recent legislation has dramatically helped high income earners with heretofore refundable minimum tax credits. On the other hand, little has been done for the average AMT taxpayer. Confress 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 for the first time. That trend is likely to continue. [ Back ]

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We Can Help With Your Tax Problems!

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) 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 not previously paid taxes and to increase the tax burdens of many middle income taxpayers. Congress has added a level of complexity to the tax laws that is beyond the grasp of virtually all taxpayers and most tax practitioners. To the layman, the AMT rules defy comprehension. There are, however, a number of planning techniques available to sophisticated taxpayers to minimize the harsh effects 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 events that Congress considers potentially abusive (read: transactions that reduce regular income tax liability).

In the opinion of this office tax return preparation software currently available on the consumer market does not give a taxpayer bullet proof computations to correctly determine AMT liability on their Form 1040. There are software weaknesses, but more importantly, it is the data input/interpretation as what is to be added and subtracted as preference items and/or AMT adjustment items which create most inaccuracies.

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.

ADJUSTMENTS

Sale of stock obtained through an employer incentive stock option plan
Passive activity losses
Tax shelter farm losses
Certain itemized deductions, e.g., state and local taxes
Post-1986 depreciation
Mining exploration and development costs
AMT net operating loss
Certain installment sales
Circulation and research and experimental expenditures

PREFERENCES

Exercise of incentive stock options
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 therefore a complicated matter. Like regular income taxes, AMT taxable income has an allowable exemption. But, similar to the regular income tax regime, the AMT exemption is phased out over certain income levels. High income taxpayers end up losing their exemptions for AMT tax purposes.

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 alternative minimum tax liability. The MTC was designed to reimburse a taxpayer for tax that is "prepaid" because of AMT. Thus, once AMT taxes are paid, a credit may be available to offset a subsequent regular income tax liability on the same transaction. 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 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.

For example, AMT taxes paid because of high itemized deductions are not subject to recapture as an alternative minimum tax credit. Itemized deductions for state income taxes paid are viewed as a permanent type of tax avoidance and therefore resulting AMT liabilities do not create MTC credits. Other AMT preference such as the exercise of incentive stock options reflect deferral considerations rather than permanent avoidance, and therefore, AMT taxes paid on account of the exercise of incentive stock options can be recaptured in later years. The exercise of an incentive stock option creates an AMT preference in the year of exercise and will often result in alternative minimum taxes even though the taxpayer is only paying for and receiving stock and is not selling or receiving cash.

AMT created and paid because of deferral preference items such as the exercise of incentive stock options will result in minimum tax credit (MTC) which in later years can be utilized against regular income tax liability. This MTC credit historically could be claimed in the year of the sale of ISO (AMT causing) stock in question or in a year of high regular income tax liability. These rules are extremely complex and require careful planning. Without an understanding of AMT and careful planning, taxpayers can and do lose the benefits of minimum tax credits.

Congress, under pressure from taxpayer and 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 mid-income taxpayers from paying the alternative minimum tax. Simple things such as a large long term capital gain in relation to the taxpayer's other income still trigger the alternative minimum tax. Exercise of incentive stock options continue to bring unwary taxpayers into alternative minimum tax liability.

For years an altlernative 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 was a Silicon Valley entrepreneur 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 saw the value of his stock fall. While the credits (MTC) were available they could not be used against ordinary income tax. This has now changed.

For tax years beginning in 2007 we have had a refundable minimum tax credits. Not only will a minimum tax credit wipe out all ordinary income tax for a taxpayer but the credit is now refundable. Here is an example of the complex language for the 2008 AMT legislation - "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". This is Code Section 53(e)(3)(a).

The long and the short of it is taxpayers who have unused alternative minimum tax credits from prior years should seek out the services of a knowledgeable tax professional to determine appropriate amounts that are currently refundable over and above the offsets to their ordinary income tax for a given year. In essence long term minimum tax credits are currently allowed to be claimed and refunded over a two year period. Also now available is a program for the abatement for interest and penalty assessments paid for pre 2008 alternative minimum tax liabilities assessed because of the exercise of incentive stock options. We can thank the 2008 TARP legislation for this dramatic change in the acceleration of the availability of AMT credit offsets to ordinary income and the acceleration of minimum tax refunds.

The AMT 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 to rear its ugly head. 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.

Conclusion:

Recent legislation has dramatically helped high income earners with heretofore refundable minimum tax credits. On the other hand, little has been done for the average AMT taxpayer. Confress 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 for the first time. That trend is likely to continue.

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Cincinnati Tax Lawyer
4555 Lake Forest Drive Suite 365
Cincinnati, OH 45242

Phone: (513) 563-4555
Fax: (513) 563-9097
E-Mail: tjutaski@cincinnatitaxlawyer.com