Itâ€™s one of the most dreaded phrases a taxpayer can hear, â€œyouâ€™re subject to the Alternative MinimumÂ
Tax.â€ If youâ€™re hearing it from your tax attorney, Â get ready to break out your checkbook becauseÂ chances are very high that youâ€™ll be paying a lot more to the federal government.
What is the Alternative Minimum Tax?
The AMT became law beginning in 1970 after a firestorm of controversy. The year before, the TreasuryÂ Department issued a report on 155 wealthy Americans who had made $200,000 (2-million in todayâ€™sÂ dollars) in income but by taking advantage of loopholes paid no income tax.Â Responding to the controversy, congress rushed the AMT into law to make sure those high earners paidÂ something.
The AMT is a tax system with its own rules and methods for calculating taxes. Quite simply, the AMTÂ eliminates many of the exemptions, tax credits, and deductions taxpayers use to reduce their tax billsÂ under â€œnormalâ€ tax rules. The AMT system is much simpler; it has only two tax brackets: the 26% taxÂ bracket and the 28% tax bracket. The result is that more income may be taxable under AMT rules thanÂ with â€œnormalâ€ tax rules. Itâ€™s up to taxpayers and their attorneys to determine which tax system to use,Â the normal one or the AMT and pay whichever one is higher.
In lower income brackets, the regular tax liability is usually higher because of AMT exemption amounts.Â In 2014, the first $52,800 for single filers and the first $82,100 for married people filing jointly wereÂ exempt from the AMT. At higher income levels, the AMT is not so forgiving.
Who Is at Risk?
The AMT is not without its own set of problems. What started as a tax patch in 1970 to stop 155Â wealthy taxpayers from completely avoiding taxes now is now a tax giant that affects roughly 3.8 millionÂ taxpayers, according to a report by the Urban-Brookings Tax Center. The problem is â€œbracket creep.â€Â The AMT was never indexed to inflation so as incomes rose the AMT qualifications stayed the same.
According to the Tax Policy Center, in 1970, the AMT collected just $122 million which was less than 1Â percent of individual tax revenue that year. By 2010, the AMT generated $102 billion, over 10% of allÂ individual income tax revenue.
So whoâ€™s at risk today? Thereâ€™s no single tax item that triggers the AMT. Itâ€™s governed by complex rulesÂ and regulations. Here are some of the most common scenarios.
â€¢ Having a large family.
â€¢ A gross income of more than $100,000.
â€¢ Holding or exercising incentive stock options.
â€¢ Receiving a large capital gain, such as selling real estate.
â€¢ Earning passive income, such as profits from stock dividends, business investments, rent orÂ commissions and royalties.
â€¢ Excessive itemized deductions, such as state and local taxes, home-equity loan interest andÂ medical expenses.
Minimizing Your Taxes
RULE ONE. If you think you or your family may be subject to the Alternative Minimum Tax you reallyÂ should be consulting with a tax professional and not trying to do your taxes yourself. The last thing youÂ want to do is make a mistake in your calculations or misunderstand a rule and end up being accused ofÂ tax evasion. A qualified tax attorney understands the rules and can save you thousands of dollars.
Meanwhile here a few steps you can take to minimize your AMT liability. Remember: This is notÂ legal advice but rather general guidelines. Please consult a tax professional for a more thoroughÂ understanding of these suggestions.
1. Put Money in your IRA and/or Retirement Accounts:Â Reduce your adjusted gross income by investing as much as you can into tax-deferred accounts,Â such as a 401(k), a 403(b), a 457(b) plan or an IRA.
2. Invest in Pre-Tax Healthcare:Â Under the AMT, medical deductions start to disappear. Instead of deducting expenses, if youÂ think youâ€™ll be hit with the AMT, sign up for a pre-tax medical deduction plan to reduce yourÂ taxable salary.
3. Be Strategic with Gains and Stock Options:Â Reduce the impact of large, one-time gains and deductions by delaying or spreading out the saleÂ of an asset. Sell stock options the same year you exercise them so you pay regular taxes on themÂ and not AMT. Once again, this is where the advice of a tax professional can be critical.
4. Get Those Business Expense Refunds:Â Ask your employer to refund your business expenses. Itâ€™s tax-free under the AMT. Under regularÂ tax rules, deductions for unpaid business expenses reduces your taxable income. With AMT, anyÂ unpaid business expenses you claim are added back to your income.
5. Take Bare-Minimum Deductions:Â Minimize your state and local tax deductions. Itâ€™s a deadly AMT trigger, by only paying propertyÂ taxes when they are due. Prepaying for state and local taxes is great when you claim them as aÂ tax deduction, but under AMT rules they come back to bite you.
The AMT has gone from simple fix to a complicated tax headache. If you think you may be subject to theÂ AMT, contact or call RJS LAW today atÂ (619) 595-1655 to come up with strategies to minimize the tax implications. A fewÂ minutes of planning now can potentially save you thousands next April.