Originally intended as a backstop to prevent tax-avoidance by high income taxpayers, the AMT now affects a soaring number of middle income taxpayers. The AMT applies if it is higher than the taxpayer’s regular tax liability.
Two factors may cause the AMT to be higher: First, many deductions allowed in calculating regular tax liability are not allowed when calculating AMT. For example, state and local income taxes, real estate taxes and miscellaneous itemized deductions are allowed as deductions in calculating regular tax liability. However, for AMT purposes, these deductions are not taken. Second, various income adjustments may propel a taxpayer into the AMT regime, or increase the AMT liability for a taxpayer already ensnared by it. For example, the exercise of Incentive Stock Options or the receipt of certain tax-exempt interest income may increase AMT, but not regular income tax, liability. Finally, depreciation of business assets is less favorable for AMT purposes than for regular income tax purposes.
One blessing to the AMT curse is that its marginal rates are lower: A 28% rate applies to AMT income above $175,000; a 26% rate to AMT income below this amount. An AMT exclusion amount of $58,000 applicable to married filing jointly is fully phased out when AMT income reaches $382,000. The AMT’s lower tax rates create some tax planning opportunities:
If it appears that a taxpayer will be subject to the AMT in 2004 but not 2005, it might be prudent to (i) defer to 2005 those deductions which are not allowable for AMT purposes since if paid or accrued in 2004 they will be wasted; (ii) accelerate ordinary income and short-term capital gains into 2004 to benefit from the lower AMT tax rate; and (iii) postpone until 2005 certain expenses (e.g., charitable contributions) which are deductible against both AMT and ordinary income, since a deduction against income taxed at the higher regular income tax rate is significantly more valuable.
Conversely, if it appears that the AMT will not apply in 2004 but will apply in 2005, it would be prudent to (i) take all deductions in 2004 which cannot be taken against AMT; and (ii) defer income to 2005 to benefit from the lower AMT tax rate.
Following a year in which the AMT applies, the taxpayer may be entitled to an AMT credit against regular income tax liability for “deferral” items, such as depreciation and passive activity adjustments. The credit ensures that the same amount of total deductions are ultimately allowed for both AMT and regular income tax liability purposes. “Bonus” depreciation will not result in a later credit since it applies to regular tax and AMT.
Long-term capital gains (LTCGs) are now taxed at 15% for both regular income tax and AMT purposes. Net LTCGs are not AMT preference items. Nonetheless, they may indirectly trigger the AMT since large net LTCGs will increase state and local taxes, which are not deductible for AMT purposes. Thus, a net LTCG could ultimately result in a denial of the deduction for state and local income taxes. Accordingly, it may be advisable to report LTCGs in a tax year in which the AMT will not be triggered by those gains.