03 Mar What is the dreaded AMT?

 Q. I hear people talking about AMT, but I have no idea what it is and why it’s bad. Can you explain?

A. AMT, or the Alternative Minimum Tax, is an alternate tax system.

AMT is calculated using a different set of tax rules than those for regular tax, said Gail Rosen, a Martinsville-based certified public accountant.

“Using the AMT rules, some deductions taken for regular tax are not allowed or are limited,” she said. “Also, certain income and expenses are recognized under different rules for AMT.”

If the AMT calculation results in a higher tax that then regular income tax, the difference is added to regular income tax on your Form 1040, Rosen said. In effect, you are liable for the AMT or regular income tax, whichever is higher.

A predecessor to the current AMT was the “minimum tax” enacted by the Tax Reform Act of 1969, which went into effect in 1970, said Joseph Matheson, a certified public accountant with Matheson & Assoc. in Whippany.

“Treasury Secretary Joseph Barr prompted the enactment action with an announcement that 155 high income households had not paid a dime of federal income taxes,” Matheson said. “The households had taken advantage of so many tax benefits and deductions that reduced their tax liabilities to zero.”

So Congress responded by creating an add-on tax on high-income households equal to 10 percent of the sum of tax preferences in excess of $30,000 plus the taxpayer’s regular tax liability, he said.

The present AMT system was enacted in 1982 to replace the minimum tax and it limits tax benefits from a variety of deductions, Matheson said. There are only two tax brackets: 15 and 28 percent.

In greater detail, under the AMT, no deduction is allowed for personal exemptions other than the AMT specific exemption, which is larger than the personal exemption except for high income taxpayers.

“One deduction that is not allowed and gets many of the lower income taxpayers is the state, local — including real estate — and foreign taxes deduction,” Matheson said. “However, most other itemized deductions apply at least in part.”

He said other individual adjustments in computing AMT include:

• Miscellaneous itemized deductions are not allowed. These include all items subject to the 2% “floor”, such as employee business expenses, tax preparation fees, etc.

• The home mortgage interest deduction is limited to interest on purchase money mortgages for a first and second residence.

• Medical expenses may be deducted only if they exceed 10% of Adjusted Gross Income, as compared to 7.5% for regular tax.

• For many executives there is an Inclusion of the bargain element of an Incentive Stock Option when exercised, regardless of whether the stock can immediately be sold.

“Many AMT adjustments apply to businesses operated by individuals or corporations,” he said. “These adjustments tend to deferring certain deductions or accelerate recognizing income.”

These adjustments include:

• The accelerated depreciation deduction over the straight line method (also using longer lives than may be used for regular tax.)

• Deductions for certain “preferences” are limited. These include deductions related to:

• circulation costs,

• mining costs,

• research and experimentation costs,

• intangible drilling costs, and

• certain amortization.

Certain income must be recognized earlier, including:

• long term contracts, and

• installment sales.

The AMT system comes with a completely different set of rates and deduction rules.

“People pay it only if their AMT tax amount is higher than their traditional taxes,” Matheson said. “Translation: If you’re paying the AMT, you are by definition paying higher taxes.”

Under AMT rules, you still start with your gross income, but many of the usual deductions and exemptions are disallowed. Even though some deductions still stand, including those for mortgage-interest and charitable donations, some other key breaks are lost such as state and local income taxes and property taxes, child tax credits and home-equity loan interest, he said.

If you want to get really specific?

Matheson said the form starts with taxable income and then adds back the deductions not allowed, and then adds the preference items. Then an exemption is applied.

For tax year 2012, the exemptions were $82,100 for married couples filing jointly, $52,800 for single and head of household filers and $41,050 for married people filing separately, he said.

“These sound high, but for states with high income and real estate taxes, the add backs for state and local taxes alone will be more that the exemption amount,” he said. “In addition, the exemptions granted under the AMT have not kept pace with inflation — while the average paycheck has.”

For instance, Matheson said, in 1982, the exemption for married couples filing jointly was $40,000. Adjusted for inflation, that would be $95,120 today.

“Thankfully, under the American Taxpayer Relief Act of 2012, the AMT will now be annually indexed to keep pace with inflation,” he said.

Taxpayers in the higher income brackets will have the AMT exemption fully phased out completely. And even though the highest tax rate under the AMT — 28 percent — is lower than that in the regular tax system — 39.6 percent — AMT filers are paying more because they’re paying on a greater amount of taxable income.

Short of moving to a low-tax state like, Texas, there is not a lot you can do to avoid the inequities of the AMT, Matheson said.

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This story was first posted in March 2015.