Tax Planning to Avoid Paying the Alternative Minimum Tax
I worked for Ernst and Young in New York City for my busy season internship. I was placed in the Financial Services Office, and more specifically, I did tax returns for high-net-worth individuals working for financial institutions. Because all of our clients were millionaires, we had to fill out IRS Form 6251 to see if a client would be subject to the Alternative Minimum Tax. During the year, my department spends a significant amount of time devising strategies to lessen a client’s AMT burden; this can be done through state withholding estimates, property tax payments and converting to a Roth IRA plan.
The Alternative Minimum Tax (AMT) was created in 1969 to ensure that ‘wealthier’ people who benefited from more itemized deductions and credits pay a minimum amount of tax. The AMT is calculated separately from an individual’s ‘1040 taxable income’ and disregards certain (primarily business-related) tax credits, thus increasing an individual’s tax liability. Generally speaking, it is advised that you complete a Form 6251 to see if you are subject to the AMT if you: make over $75,000 a year, exercised any incentive stock options, wrote off personal-exemptions, own a business, received any K-1s, or own S-corporation stock. Form 6251 essentially adds back any personal and dependent exemption deductions ($3,700 per person for 2011), the standard deduction for those who do not itemize ($5,800 for an individual, $11,600 for married filing jointly). For those who do not use the standard deduction, they must add back certain itemized deductions like investment expenses, employee business and some medical and dental expenses. Additionally, Form 6251 includes the spread between the market price and the exercise price of incentive stock options as income, whereas this spread is ignored on the 1040. Lastly, Form 6251 adds back any state, local and foreign income taxes paid, property taxes written off, and interest on home equity loans that are not used for home improvements.
Because the taxpayer looses so many deductions under the AMT system, the taxpayer is usually subject to greater liabilities under the AMT. However, unlike the regular tax system, the AMT maintains a maximum income tax rate of 28%, versus 35%. “Thus, if a taxpayer's marginal tax rate under the regular income tax rules is lower than 28% because he has deductions he cannot use under the AMT system, he or she will pay income tax based on the AMT system. In that case, each additional dollar of income will be taxed at 28% until all of the taxpayer's previously unused deductions under the regular tax system are used up and his or her marginal tax rate exceeds 28%. This is often referred to as the "crossover point."” At Ernst and Young, I learned that the primary object of tax planning was to either accelerate income of taxpayers who were subject to the AMT, thus taking advantage of the 28% tax rate on this accelerated income, or to try to postpone certain expenses and deductions to a later year when they will have no AMT liability.
While the AMT was intended to apply to high-income tax payers, it often ends up hitting the middle class and those with larger families. Furthermore, because the Tax Relief Act of 2010 expires at the end of 2012, the number of individuals effected by the AMT is expected to rise significantly in 2012. Because the AMT negates to account for inflation, every year for the past several years, Congress has passed a
“patch”, such as the Tax Relief Act of 2010, which has provided inflation relief plans. However, this temporary patch is set to expire in 2012, resulting in significantly higher estimates of the number of people who will be paying the AMT next year. Under the Tax Relief Act of 2010, the AMT has effected less than .2 percent of married couples who have an adjusted gross income between $75,000 and $100,000 and two children; however, once the patch expires in 2012, this...
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