Alternative Minimum Tax
Prepare for This "Tax Trap"
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.
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, the higher amount is usually paid.
Major deductions disallowed in computing the alternative minimum tax include itemized deductions for property taxes, state personal income taxes, and certain miscellaneous itemized deductions and personal exemptions for dependents and the taxpayer. Interest expense from home equity lines of credit may also be disallowed.
Since the same tax rate applies to long-term capital gains and qualifying dividends when computing the regular tax and the AMT, while state income taxes, state sales taxes (for 2004 through 2007) and property taxes aren't deductible for AMT, the AMT will commonly apply when a taxpayer has a big long-term capital gain and/or a lot of qualifying dividends.
Also, since the maximum federal income tax rate has been reduced to 35% while the maximum federal AMT rate remains at 28%, more taxpayers are becoming subject to the AMT simply because they have big tax deductions for state income taxes, property taxes and certain home equity lines of credit.
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.
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 are more than three years old could be refundable for tax year 2007 through 2012, but severe limitations apply.
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. However, we are finding the tax applies more and more often, including middle class taxpayers.
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 2007. Call Michael Gray at 408-918-3161 to find out if we 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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