Alternative Minimum Tax
Created to ensure the wealthy paid at least some taxes, the AMT is hitting some tax payers well below that belt.
It’s the IRS sucker punch: make too much money and have too many deductions, and you get ejected from the regular tax brackets into the dimension of alternative minimum tax. The original intent of the 1969 AMT had noble roots – ensure the nation’s wealthy couldn’t shelter all their income through deductions.
Over the ensuing years, the popular and practical definitions of “wealthy” adjusted for inflation, but the IRS code didn’t. Congress has approved inflation-adjusted “patches” for many years, including as part of the American Recovery and Reinvestment Tax Act of 2009, signed by President Obama in February 2009. However, the patch only covered the 2009 tax year. Finally, after years of being subject to a last minute scramble by Congress to “patch” the exemption, the American Taxpayer Relief Act of 2012 (ATRA) set the AMT to be permanently adjusted for inflation. For 2016, the AMT exemptions are $53,900 for singles, $83,800 for married couples filing jointly or qualifying widow(er)s, and $41,900 for married filing separately.
For years, instead of a tax net for the wealthy, the AMT was considered the “stealth tax,” torpedoing upper-middle class taxpayers who don’t see it coming until they hit line 44 of their 1040. According to the Urban-Brookings Tax Policy Center, just 20,000 taxpayers fell under the AMT in 1970. By 2006, that number had grown to nearly 4 million. And before the ATRA, the IRS estimated the AMT would have applied to more than 30 million taxpayers in 2012. Instead, just 3.4 million owed AMT in 2013.
Still, the AMT is not perfect. The problem with the AMT lies not in its tax rate – 26 percent or 28 percent compared to the 39.6 percent top bracket of the regular tax system – but in the deductions it disallows. You can still take mortgage interest and charitable donations, but the AMT excludes state and local income taxes and property taxes, unreimbursed business expenses, child tax credits, tax preparation fees, legal fees and home-equity loan interest.
Without those exemptions, you end up with higher taxable income. Simply living in a state with high property taxes or having a large family can trigger the AMT, as can a mortgage deduction.
Exercising incentive stock options may be the biggest, most unexpected whammy. Under the AMT, the difference between the exercise price and the market price counts as income. Before you exercise incentive stock options, consult a financial professional. The number of options you exercise and the timing can significantly impact the amount of taxes you’ll owe on the gain.
Private activity bonds, municipal bonds for public projects like airports and stadiums, lose their tax-free status in AMT land. The offering circular for these bonds usually carries a disclaimer saying they may be subject to the AMT. Consult your financial professional before investing in or selling private activity bonds.
The usual tax strategy of delaying income and maximizing deductions may push you into the AMT zone. A financial or tax professional can help you balance ordinary income against deductions, including state taxes and when you pay them, to at least minimize if not eliminate the AMT hit. Such planning should look beyond the present tax year to ensure that minimizing AMT exposure in the current year doesn’t maximize it the next.
Even with the ATRA in place, the best strategy will be constant vigilance and competent tax and financial counsel to ensure the AMT doesn’t take the wind out of your financial sails.
Pursuant to IRS Circular 230, Securities America Inc. is providing you with the following notification: The information contained in this article is not intended to (and can not) be used by anyone to avoid IRS penalties. Neither Securities America nor its representatives are permitted to give tax advice. Any discussion of tax rules included in or related to this article is for general informational purposes only. Such discussion does not purport to be complete or to cover every situation. Consult a qualified professional for tax advice specific to your situation.
Securities offered through Securities America, Inc. Member FINRA/SIPC. Jose R. Rodriguez, Financial Consultant. Advisory Services offered through Securities America Advisors, Inc. An SEC Registered Investment Advisor, Jose R. Rodriguez, Investment Advisor Representative. Rodriguez Financial Strategies LLC and the Securities America companies are unaffiliated. Written by Securities America for distribution by Jose “Rafi” Rodriguez, Retirement Income Certified Professional®. Securities America and its advisors do not provide tax advice. Please consult with your tax professional regarding your individual situation.” SAI#1097609.2