A Discussion of the Alternative Minimum Tax

I know you must be frustrated with this alternative minimum tax but do you really know what it is all about? Chances are you don’t fully understand. I will attempt to explain the alternative minimum tax to you and offer some tax planning strategies to help you endure.

The alternative minimum tax (AMT) is a tax calculation that is run simultaneously with the regular income tax calculation. The AMT is was originally designed to keep taxpayers from taking too much advantage of income tax deductions and potentially limiting the amount of income tax to be paid. If a taxpayer had certain deductions or exercised incentive stock options without selling the stock, there would quite likely be exposure to the AMT. The funny thing is, these days a taxpayer doesn’t have to have a bunch of deductions or a complicated tax structure to all into the AMT. In fact, many who are in the AMT are married filing joint returns with just the normal course of itemized deductions. When the married filing joint tax tables were adjusted to reflect twice the single tax rates(an attempt to eliminate the marriage penalty), more of these tax returns were in the AMT as a result of phasing out the lower income tax brackets. The lower income tax brackets of 10% and 15% were phased out by applying the AMT rate of 26% form most taxpayers. Throw in the fact that taxes taken as itemized deductions and miscellaneous deductions subject to the 2% adjusted gross income floor are add backs to arrive at alternative minimum taxable income, its no wonder that more Americans found themselves in this predicament.

The best way for the average American to avoid, or lesson the effects of the AMT is to reduce income. Increasing contributions to 401K’s is an excellent way to do this. This serves to reduce both regular tax and AMT. In fact, I have run scenarios that have gotten the taxpayers out of the AMT by reducing income through use of a 401K. Another helpful task is to reduce state income taxes withheld. This is an addition to arrive at AMT taxable income. If one is making estimated tax payments, don’t make the fourth quarter estimate in December, wait and make it in January. This will reduce exposure during the current year and will make it possible for a deduction in the following year. The same principal applies for those having state taxes withheld from their pay. Reduce withholding to the bear minimum. If one typically gets refunds on the state return, claim more exemptions to lesson the tax withheld. In fact, it might make sense to reduce withholding down to an amount that would have an amount due on the return. This amount due would be paid in the following year and can be calculated to avoid penalty and interest for the current year’s return. My favorite tactic for reducing exposure to regular tax and the AMT is getting reimbursed for un-reimbursed expenses. If one is an outside salesman, then there is definite chance that these expenses are helping to bring on the AMT. Here’s how this can work. In lieu of getting a bonus or commission check, have the employer reimburse for the expenses instead. This will provide income that is not subject o tax. The income will not be placed on the W-2 form and will therefore lower exposure to regular tax and the AMT.

These are a few of the ways to help cope with what I call operational AMT. Operational AMT does not require the use of amazing tax attributes and finds its way to the taxpayer by virtue of where the tax bracket falls and the type of normal deductions taken. Situational AMT involves specific transactions like exercising ISO’s or the sale of Internal Revenue Code 1202 stock. Situational AMT will often provide a credit that can be carried forward to offset regular tax in a future year, subject to limitations. I will discuss this more in a later article. For the time being, it is important to know how one’s income will fall over the next few years in order to plan for operational AMT. Calculate your own exposure to AMT by filling out form 6251 for the current year as well as the next three or four years. If you need help, you know where to find me.

Ron Piner, CPA
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