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Alternative Minimum Tax

Alternative Minimum Tax . Lawrence Zimbler. OBJECTIVES. Distinguish between timing and permanent adjustments to alternative minimum taxable income (AMTI) Identify preferences and exclusions to arrive at AMTI. Implement methods to minimize the impact of AMT

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Alternative Minimum Tax

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  1. Alternative Minimum Tax Lawrence Zimbler

  2. OBJECTIVES • Distinguish between timing and permanent adjustments to alternative minimum taxable income (AMTI) • Identify preferences and exclusions to arrive at AMTI. • Implement methods to minimize the impact of AMT • Identify scenarios where AMT is assessed in one tax year but may result in a future minimum tax credit. • Complete Forms 6251 and 8801

  3. History of the AMT • In January 1969, Treasury Secretary Joseph W. Barr informed Congress that 155 wealthy individual taxpayers with incomes exceeding $200,000 (> $1 million in 2011 dollars) had paid no federal income tax in 1966. • The news created MASSIVE public pressure on Congress to address this problem. Constituent letters on this exceeded those in re: the war in Vietnam. • TRA ‘69 created a minimum tax to prevent wealthy individuals from taking undue advantage of tax laws to reduce or eliminate their federal income tax liability through special deductions, credits, etc. • The alternative minimum tax statute never invoked inflationary adjustments

  4. History of the AMT • In 1970, only 19,000 taxpayers owed an AMT, at a 10% flat rate. • Numerous changes since…The National Taxpayer Advocate and the Internal Revenue Service, have called the AMT one of the most difficult tax law areas to comply with and administer. • In 2010, slightly more than three million taxpayers paid some amount of alternative minimum tax. That number could grow to 30 million by 2010 if current “patches” are not continued, or the law revised.

  5. History of the AMT • Both major political parties want a permanent correction to the problem however finding replacement revenue has proven difficult. • Temporary patches expire on 12/31/2011 • Without changes, 2012 could see more than 30 million taxpayers affected by AMT.

  6. What is the AMT • A second, independent tax system. • Figure tax under regular tax rules • Then re-compute tax using AMT rules • Then pay the higher of the regular tax or the AMT. • AMT deductions and exclusions are much more restrictive than for regular tax; many regular tax items don’t apply at all. • Procedurally, start with regular tax taxable income then add or subtract preferences and adjustments. • Form 6251 may be required even when no AMT is computed.

  7. Form Requirements • File Form 6251 whenever: • Line 31 > line 34 (AMT is due) • Any of the following credits are claimed: • General Business Credit, Form 3800and Line 8 or Line 24 of Form 3800 > 0 • Electric Vehicle or Alternative Vehicle • Alternative Fuel Refueling Property • Prior Year AMT – Form 8801 • Sum of Form 6251 lines 8 – 27 < 0 ANDForm 6251 line 31 would be > line 34 if lines 8 – 27 were ignored.

  8. Adjustments for AMT • Adjustments to taxable income for AMT purposes are called “tax preference items” • Tax preference items might be “deferral preferences” or “exclusion preferences” • Deferral preferences are sometimes called “adjustments” • Deductions that over the course of multiple tax years, will equal in the aggregate between the regular tax and AMT, but which differ in the current year are deferral preferences. • Deferral preference usually will be + or - • Exclusion preferences are items that reduce regular tax permanently and are not allowed for AMT.

  9. Exclusion Preferences • Most common exclusion preferences [IRC §56(b)(1)]: • Personal Exemption - Line 1 • Standard Deduction - Line 1 • Schedule A Items • Medical < 10% of AGI - Line 2 • All taxes (Sch A, line 9) - Line 3 • also remove tax refunds from AMT income • Certain Mortgage Interest (from worksheet)Line 4 • Miscellaneous Deductions - Line 5

  10. Exclusion Preferences

  11. Line 4 – Mortgage Interest • Some mortgage interest may not be deductible for AMT purposes. • Mortgage conditions: • Proceeds used to buy, build or improve • Primary or secondary home • Used by self or family, not transient • Not a “cash-out” refinance • CAUTION: Your software may not do this for you! Or may require a separate manual entry.

  12. Line 4 – Mortgage Interest In 2010, Dave and Jennifer paid $10,000 in interest on a mortgage they took out to buy their home (an “eligible mortgage”). In May 2010, they refinanced that mortgage and paid $9,000 in interest through the rest of the year (not an “eligible mortgage”) The balance of the new mortgage is the same as the balance of the old mortgage. In July 2010, they obtained a home equity loan on their home and used the proceeds to buy a new car. They paid $5,000 in interest on the home equity loan in 2010.

  13. Do not include any interest paid on (or any qualified mortgage insurance premiums paid in connection with) the part of the balance of the new mortgage that exceeded the balance of the original eligible mortgage immediately before it was refinanced…

  14. Other Exclusion Preferences • Depletion, Line 9[IRC § 57(a)(1)] • Considered an exclusion preference even though it can be a negative number. • Depletion is re-calculated using AMT allowed amounts of income and deduction, then limited to AMT adjusted basis • Re-calculation is done property by property • Difference ( + or - ) is the tax preference amount • EXCEPTION provided for • Independent producer or royalty owner who • Uses percentage depletion for oil & gas wells

  15. Other Exclusion Preferences • Private Activity Muni Bond Interest, Line 12 • Reduce by any expenses that would have been deductible if the interest had been taxable for regular tax purposes. • Use an AMT recalculated Form 4952 to deduct any disallowed interest expense related to these muni bonds. [IRC §57(a)(5)(A)] • Gain on Qualified Small Business Stock (IRC §1202), Line 13 • 7% of the excluded gain is preference[IRC §57(a)(7)]

  16. Deferral Preferences All AMT adjustments are deferral preferences except for the enumerated exclusion preferences. Generally, deferral preferences can and will, in some years, reduce Alternative Minimum Taxable Income (AMTI); and in other tax years increase it.

  17. Deferral Preferences • Common deferral preferences: • Depreciation • Incentive Stock Options • Disposition of Property • Passive Activities

  18. Deferral Preferences Depreciation

  19. Depreciation • Regular tax (MACRS) allows 200% DB with a 3, 5, 7 or 10 year cost recovery period for tangible personal property • AMT permits a maximum of 150% DB; Straight line is OK for AMT • Property in service before 1/1/99 must use a separately determined cost recovery period for AMT purposes. • Find the appropriate recovery period in IRS Pub 946.

  20. Depreciation Examples • Consider an asset, cost $1,000Personal property used in business • For examples, we’ll consider the depreciation calculations for the following: • 5 year 200 DB - a computer, etc. • 7 year 200 DB - office furniture, etc. • Your tax software should do all this automatically IF you enter correct data

  21. Depreciation 5 year property, cost $1,000

  22. Depreciation 7 year property, cost $1,000; post 1998

  23. Note that if the property were sold at the end of year 4 for $500, there would be a gain for regular tax purposes and a loss for AMT purposes. Depreciation 7 year property, cost $1,000; pre-1999; 10 year recovery

  24. Depreciation – no AMT… • Property placed in service after 1998 may NOT have to recalculate AMT depreciation: • Real Estate & other 1250 property on which straight line depreciation is claimed. • Other property using 150%DB or Straight Line depreciation. • Section 179 and Bonus depreciation are not subject to any AMT adjustment. • Property using the Alternative Depreciation System (ADS) for regular tax is not adjusted. • Some others.

  25. Deferral Preferences Stock Options

  26. Stock Options • Statutory option • meets requirements of IRC §421 through§424 • includes incentive stock options (ISOs) and options issued under employee stock purchase plans. • no tax consequences on the GRANT of statutory options • no regular income tax consequences when a statutory option is exercised and stock of the employer is transferred to the employee. However, the bargain element -- the difference between the exercise price and the option stock's value at exercise, is an AMT adjustment. • Gain realized on the sale of the option stock is all capital gain, provided holding periods are met. If the holding periods aren't met, some of the profit is ordinary income. • not subject to FICA

  27. Stock Options • Non-statutory option • A compensatory stock option that does not meet the requirements for incentive stock options or employee stock purchase plan options. • Subject to withholding and FICA. • Taxed to the employee at its grant if it has a readily ascertainable fair market value at that time, (many don't). • If the option's value at grant isn't readily ascertainable, tax is imposed at ordinary income rates at the time the option is disposed of or exercised, or, if later, when the stock becomes transferable or is no longer subject to a substantial risk of forfeiture. • No AMT consequences.

  28. Incentive Stock Options (ISO) • A qualified ISO will have the following characteristics: • Grant Date • Vesting Date • Expiration Date • Exercise Price • Number of Shares • Option price will be FMV price on the grant date. • LT holding period is GREATER of 2+ years from grant or 1+ year from exercise.

  29. Incentive Stock Options • The ISO gives the employee the right to buy a specified number of shares at a specified price within the period between the vesting date and the expiration date. • On exercise, the difference between the option price and FMV is [hopefully] substantial. • This difference is not subject to regular tax. • This difference is subject to AMT, called the “bargain element.” • Options are “underwater” while the option price is higher than FMV.

  30. Incentive Stock Options • Cashless Exercise: • Employee exercises the ISO, but immediately sells the stock, and uses the sale proceeds to pay the option price. • Disposition within same tax year of ISO stock is a disqualifying disposition. • A cashless exercisewill be reported on Form W2 (and also on Form 1099B). • Inclusion in W2 buys “tax cost basis” therefore, Schedule D usually shows a loss in the amount of the transaction charges.

  31. Incentive Stock Options Example Facts: Joe is awarded an ISO on January 2, 2006 to buy up to 500 shares of XYZ at $15. XYZ trades at $17.65. The option vests in 24 months. If Joe leaves employment before January 3, 2008, he gets nothing. During January 2010 XYZ is trading around 16.00. However, in mid 2010 it starts rising significantly. By February, 2011, XYZ is trading at $75.15

  32. Incentive Stock Options Situation 1: Joe decides to do a cashless exercise of his option. His 500 shares are sold for $37,575 less fees of $45; and the $7,500 purchase price is taken from the sale proceeds. Joe gets a check for $__________. What is the tax consequence: regular tax? alt min tax?

  33. Incentive Stock Options Joe has a full cost basis of $7,500 in the sold stock. So his realized gain is $30,075. As a disqualifying disposition, this is ordinary income. $30,075 is included in Boxes 1 of his W2, and Box 14 code V, and his net check is $22,556 after 25% federal withholding. He gets a 1099B for $37,575 and claims $37,620 basis (7,500 cost basis + 30,075 tax-cost basis + $45 fees) and reports a $45SHORT TERMloss. There is no AMT consequence – AMT treatment is identical.

  34. Incentive Stock Options Situation 2: Joe thinks that the $75 share price is safe for a period of time, maybe it will even rise. On March 1, 2010 Joe takes $7,500 from his savings and exercises the option but does NOT sell the stock. On March 3, 2011 the stock price drops to $74 and Joe sells the 500 shares. He gets a check for $36,850 ($37,000 proceeds - $150 commissions). What are the regular and AMT consequences?

  35. Incentive Stock Options • In 2010 the difference between the $7,500 option price paid and the $37,575 FMV ($30,075) is not income for regular tax purposes. [IRC 421(a)] • Joe’s [regular tax] basis is $7,500. • The $30,075 difference is a tax preference for AMT purposes, and Joe must report $30,075 on line 14 of Form 6251. As a result, he may owe AMT in 2010, but he also gains a $37,075 AMT basis in that stock.

  36. Incentive Stock Options Joe’s holding period begins on the exercise of the option. By holding the stock for 1+ year, he’s entitled to LTCG tax treatment. In 2011 when he sells for $37,000, he has a LTCG of $29,350 ($4,403 regular tax) but he now has a loss of $725 for AMT purposes. This translates into a negative AMT adjustment of ($30,075) on line 17 of his 2011 Form 6251. In addition, all or part of any 2010 AMT that resulted from the 2010 preference may be allowed as a credit against 2011+ regular tax.

  37. Incentive Stock Options A taxpayer who exercised incentive stock options in Year 1 to buy Company stock couldn't use the AMT capital losses he realized in Year 2 when the Company went bankrupt and his stock became worthless, to reduce his Year 1 AMTI. Merlo, Robert J., 126 TC 205 (2006) , affd (2007, CA5) 100 AFTR 2d 2007-5204 , 2007-2 USTC ¶50554

  38. Incentive Stock Options Planning Tip: If stock acquired by exercise of an ISO would result in a significant AMT because the value of the stock at exercise exceeded the cost to buy it, and the stock price later (but before year-end) declines dramatically, consider selling the stock before year-end in order to avoid recognizing the AMTI from the spread at exercise.

  39. Incentive Stock Options Planning Tip: Employees should consider exercising their ISOs as early as possible in the year. If the stock value falls, the employee may be able to sell the stock before the end of the year. While this may result in any profits being taxed at higher ordinary income tax rates, it can reduce or eliminate the AMT liability, and ensure that taxes are paid on the actual profit realized. If, on the other hand, the price rises during the year, or declines only modestly, the employee can wait until the next year to sell the stock, locking in the long-term capital gains rate.

  40. Deferral Preferences Adjusted Gain/Loss

  41. Adjusted Gain or Loss • Assets maintain a separate basis for AMT purposes from regular tax purposes; because items that adjust basis may be computed differently for AMT. • With different adjusted bases, an asset may have a different amount of gain or loss upon sale for regular tax purposes than for AMT purposes. • This difference is shown on Form 6251line 17

  42. Adjusted Gain or Loss 7 year property, cost $1,000; post 1998

  43. Adjusted Gain or Loss And remember Joe’s ISO… • Joe’s regular tax basis is $7,500. • The $30,075 difference is a tax preference for AMT purposes, and Joe must report $30,075 on line 13 of Form 6251. He may owe AMT in 2007, but he also gains a $37,075 AMT basis in that stock. • In 2011 when he sells for $37,000, he has a LTCG of $29,350 ($4,403 regular tax) but he now has a loss of $225 for AMT purposes. This translates into a negative AMT adjustment of ($30,300) on line 16 of his 2011 Form 6251.

  44. Adjusted Gain or Loss • Other places that might generate a gain/loss difference for AMT: • Disposition of a passive activity • Disposition of a PTP • Different AMT Capital Loss Carryover • Casualties

  45. Adjusted Gain or Loss • The reportable gain or allowable loss under AMT rules must be calculated and compared with the gain or loss reported for regular tax purposes. • Remember that for AMT purposes, net capital losses are still limited to $3,000 ($1,500 if MFS) • The difference goes to Form 6251, line 17. • The difference might be either positive or negative (often negative).

  46. Deferral Preferences Passive Activities

  47. Passive Activities • Allowable passive activity loss is computed using Form 8582 and related worksheets. • For AMT purposes, it helps to (and most software will) create a separate Form 8582 and worksheets to re-compute the allowable passive activity income or loss for the year. • The difference between the amount of passive income reported, or passive loss allowed for regular tax purposes, and the amount calculated for AMT purposes is shown on Form 6251, line 18

  48. Passive Activities Example: Joe invested in a limited partnership several years ago. This activity is passive in his hands and has been reporting losses each year. These losses have been suspended by the PAL rules, and for 2010, he has carryover loss for regular tax purposes of $1,256 and for AMT purposes $982. In 2009, Joe also invested in a second passive activity designed to produce income (a PIG) to get some tax benefit from his other losses. His 2010 Schedules K1 look like the following:

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