Topics covered in tax bulletin articles:
1 Deductions
There
appears to be more and more discussion of Alternative Minimum Tax (AMT) in the
newspapers. I want to review some practical aspects of AMT and its incidents so
you will have a basic knowledge of
what it is and how bad it is or is not.
Practically, AMT is like a flat tax. You have heard that some propose a
flat tax -- actually, we already have one. This is a flat tax system that is
calculated parallel to the regular tax and you pay based on whichever is the
larger. In the following discussion, I will not list all the differences between
the regular income tax system and A.M.T, but only those that are likely to have
some impact on you.
The AMT flat tax system taxes some "income" items that the
regular tax system does not, for instance --
1.
It taxes the difference between the fair market value and the exercise price in
the exercise of qualified (incentive) stock options.
2.
Under old law, when the benefit of having long-term capital gains was that 60%
of the gain was excluded from income and thus
only 40% was taxed (which at a 50% maximum tax rate gives one about the
same benefit we have now). When that was the law, the 60% excluded for regular
income tax was added back into income for the calculation of A.M.T.
Under current law, the benefit of significant long-term capital gains is
also lesser under A.M.T than for regular income tax. While for regular income
tax, the tax rate for long-term capital gains is 20% (10% for
individuals/families in the 15% tax bracket), the A.M.T. rate is 26% (and 28%
above a AMT income of $175,000). The fact that long-term capital gain income is
taxed at a higher rate by A.M.T. than by the regular income tax system means
that a greater amount of capital gain income, the A.M.T. will be greater than
your regular income tax.
Either the effect of significant incentive stock option exercise or of
significant long term capital gain income will usually mean that you have A.M.T.
If you have both, it is very difficult to avoid A.M.T.
The A.M.T. flat tax system also only allows a few non-business
deductions. Specifically it disallows:
1.
Any deduction for taxes -- including state income tax, real property tax or
personal property tax (such as D.M.V. fee)
2.
The deduction of medical expenses between 7.5% and 10% of
adjusted gross income. Thus although medical expenses in excess of 7.5%
of adjusted gross income can be deducted for regular income tax purposes, other
those in excess of 10% of adjusted gross income can be deducted for A.M.T.
3.
Interest paid on an equity line of credit, which is not qualified housing
interest. This is interest which meets the requirement for regular income tax
deduction but from a loan not used to purchase, build or substantially improve
taxpayer's residence.
4.
Most deductions for miscellaneous itemized deductions, such as union dues, safe
deposit box fee, trustee fees, I.R.A. management fee, and unreimbursed employee
business expense. Although you can only deduct these kinds of expenses to the
extent that they exceed 2% of your adjusted gross income, for A.M.T., you are
allowed no deduction at all.
Also, the allowable deduction for depreciation is less and for some
property, much less, than for A.M.T. Although it is possible to have purchased a
single family residence or apartment house in 1985 and be using a depreciable
life of 19.5 years for regular income tax purposes, the depreciable life for
A.M.T. purposes is 40 years. For real property purchased in 1986 or later, the
depreciable life for regular income tax is 27.5 years, and for A.M.T., 40 years.
The practical effect of A.M.T. is that you pay more tax than you planned
on. Taxpayers plan on certain deductions and when the time to file rolls around,
they can be unhappily surprised to find that their tax bill is higher than
expected because they are in A.M.T.
Except for having significant employee business expenses, a large rental
real estate portfolio or a fabulous year in the stock market, in which you
generate an enormous amount of capital gain -- so fabulous and enormous you
certainly would not want to forego it -- in many other cases, the onset of A.M.T.
can be put off to a great extent by careful planning.
1.
Usually there is a window of several years for exercising incentive stock
options -- you should consider spreading the exercise over several years. Also,
usually the difference between fair market value and the exercise price is
usually small at the start of the time-window so that you would have a much
smaller affect on A.M.T.
2.
If you are making stock sales near the end of the year, consider waiting until
the start of the next year. This
would not only defer the gain until next year, but could mitigate the effect of
A.M.T. Also, make sure to look for losses to take by year-end.
3.
If you are going to have a year of unusually large amount of income, calculate
the maximum amount of California income tax that you can deduct. What you want
to avoid is having a lot of regular income with a high tax rate and not pay your
CA tax, putting it off to a year of relatively high capital gain income. You
could lose most of your deduction for CA taxes that way. Real property taxes
follow that same logic. Frequently you need to run the numbers--calculate your
tax-- by year end in order to do good planning.
Although CA generally follows Federal law in its calculation of CA AMT,
there is one nasty wrinkle. Although Federal now allows a deduction for the fair
market value of securities given to public charities for regular income and AMT
purposes, CA does not. CA allows a deduction for the fair market value of the
securities for regular income tax purposes but only for the cost of the
securities in the computation of CA AMT. Another good reason to run the numbers
for accurate planning at year end.
Copyright
Eleanor Hansen 1999