Alternative Minimum Tax
Prepare for This "Tax Trap"
© 2018 by Michael Gray, CPA
The Alternative Minimum Tax (AMT) was created so that taxpayers with substantial income would pay some tax. Many voters were outraged by statistics published by the Treasury Department that several taxpayers had substantial income, but were able to avoid paying income taxes using tax deductions, incentive tax credits, and tax shelter investments.
There were significant changes to the tax laws in the Tax Cuts and Jobs Act of 2017 that will reduce the impact of the Alternative Minimum Tax for 2018 - 2025, but it was NOT repealed for taxpayers that aren't C corporations.
In 1986, the AMT was modified to be similar to the flat tax many people had proposed-a single tax rate applying to a broadened tax base with an exclusion amount The income tax is computed using the regular tax and AMT, and the higher amount is usually paid.
Under the Tax Cuts and Jobs Act of 2017, most of the regular tax deductions that were not deductible when computing the alternative minimum tax were repealed or severely curtailed, including repealing miscellaneous deductions subject to the 2% of adjusted gross income floor, interest for most equity lines of credit, and personal exemptions for dependents and the taxpayer. The deduction for the combined amount of state income taxes and real estate taxes is limited to $10,000 for the regular tax and not deductible when computing the alternative minimum tax.
The elimination or curtailing of these deductions means alternative minimum taxable income will be much closer to regular taxable income unless there is a significant "timing difference," such as the exercise of an incentive stock option with a lot of deferred income. (See below.)
The standard deduction was also temporarily increased for 2018 - 2025 to $24,000 for married individuals filing joint returns, $18,000 for heads of households, and $12,000 for other individuals. It will be indexed for inflation after 2018. The standard deduction is not deductible when computing the alternative minimum tax. See below about the increase in the alternative minimum tax exemption, which should eliminate the alternative minimum tax for most taxpayers.
A significant AMT adjustment affecting many Silicon Valley executives is the spread between the fair market value and the option price for stock acquired using incentive stock options.
Many changes have been made to the AMT over the years. Most significantly, graduated tax rates were added to the tax computation effective in 1996, thus eliminating the original "flat tax" design. There are currently 26% and 28% tax brackets.
Under the Tax Cuts and Jobs Act of 2017, the alternative minimum tax exemption was temporarily increased for 2018 to 2025 to $109,400 for married taxpayers filing joint returns and $70,300 for all other taxpayers. The AMT exemption is phased out at $1 million of tentative alternative minimum taxable income for married taxpayers filing joint tax returns and $500,000 for all other taxpayers (other than estates and trusts). These thresholds will be indexed for inflation after 2018. With the increase in the exemption and the elimination of itemized deductions, many taxpayers who paid the alternative minimum tax in the past will no longer be subject to the tax.
A part of the AMT could represent a prepayment of tax and be used as a tax credit in a later year. Part of minimum tax credits that were more than three years old could be refundable for tax years 2007 through 2012, but severe limitations applied. The refundable minimum tax credit has expired and is no longer available.
Many taxpayers who prepare their own income tax returns and some tax return preparers have ignored the AMT because they aren't aware of it, don't understand it, or believe it doesn't apply. Making the computation is still critically important when a taxpayer has a minimum tax credit carryover. The lowest alternative minimum tax rate is 26% while the lowest regular tax rate is 10%. It's still possible to unexpectedly owe the tax.
We consider the AMT important to consider when preparing income tax returns and in tax planning computations. When the tax situation is planned in advance, you can avoid wasting deductions disallowed under the AMT. You can also prepare in advance for the cash required to pay the tax, be sure estimated tax payment requirements are met, and plan to use minimum tax credits.
Now is an excellent time for planning your tax situation for 2018. Call Thi Nguyen, CPA at 408-286-7400, extension 206 to find out if Koehler & Associates CPAs, Inc. are the right CPAs for you.
For more information about the alternative minimum tax, visit our FAQ page. Have employee stock options? You may also be interested in The Amazing Disappearing AMT Credit.
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