Alternative Minimum Tax
Posted on June 18, 2008
Filed Under Alternative Minimum Tax
The second tax system known as the alternative minimum tax (AMT) is a federal policy subject to a basic tension: Congress believes taxes should be a shared burden, but at the same time, Congress has crafted the Internal Revenue Code so that wealthy individuals and large corporations can avoid or drastically reduce their tax liability. Add to this tension the tendency of Congress to soothe the public’s complaint about federal income taxes with the apparent saving power of attractive riders and supplements to the Code that are ultimately negated by the broad reach of the AMT.
This tension notwithstanding, the AMT is a second regime that subjects individuals and corporations to a broader tax base at somewhat lower rates (26 or 28%) than the regular tax system (top rate of 35%). (Note: In this article I focus on the AMT for individuals.) To determine whether a taxpayer is at risk for the AMT, it is first necessary to determine the AMTI, abbreviation for alternative minimum taxable income.
The first step in calculating AMTI is to make several adjustments to regular taxable income. Under the AMT system, straight line depreciation on a 40 year schedule substitutes for accelerated depreciation under the Modified Accelerated Cost Recovery System (MACRS) for real property acquired before 1998, and a 150 percent declining balance depreciation method replaces other methods for property not subject to straight line depreciation under the regular system. In short, under the AMT, the taxpayer loses the substantial time value of money deferrals associated with accelerated depreciation under the regular tax system. In calculating AMTI, the taxpayer also substitutes the percentage of completion method of accounting for long-term contracts for other methods, including the completed contract method and the cash basis method; adds back passive farming losses; adjusts incentive stock options for the excess of the stock’s fair market value at exercise date (pdf file) over the amount paid; refigures any net operating losses (pdf file) and any gain or loss on sales or other dispositions of assets; removes personal exemptions; takes out miscellaneous itemized deductions (pdf file); and recomputes medical and dental expenses (pdf file) to reflect the higher 10% of adjusted gross income floor for these expenses under the AMT system. For a complete listing of adjustments to regular taxable income see 2007 IRS Form 6251 Alternative Minimum Tax–Individuals (pdf file) and 2007 Instructions for Form 6251 (pdf file).
Second, add back tax preference items forbidden by the AMT to regular taxable income. These tax preference items include percentage depletion (pdf file) in excess of basis of assets (pdf file) for oil, gas, and all other mineral resources; intangible drilling costs in excess of 65% of net income from oil, gas, and geothermal wells; interest earned on tax exempt private activity bonds (pdf file); accelerated depreciation or amortization on properties acquired before 1987; and the exemption for gains on small business stock.
Third, subtract the exemption amount to arrive at net alternative minimum taxable income. For married taxpayers filing jointly and surviving spouses, the exemption amount is $62,550; for single individuals, $42,500; and married taxpayers filing separately, $31,275. The exemption is phased out or reduced 25% of the amount by which AMTI exceeds $150,000 for surviving spouses and married filing jointly (exemption completely phased out at $400,200), $112,500 for single individuals (exemption exhausted at $282,500), and $75,000 for married filing separately (exemption ends at $200,100).
Fourth, multiply the net AMTI by either a 26 or 28% rate. The first $175,000 of AMTI is taxed at 26% and AMTI over $175,000 at 28%. But the AMT system uses the same rates as the regular tax system for dividends (15%) and long-term capital gains (15% or 25%).
Fifth, from this subtotal, subtract any personal nonrefundable credits and the AMT foreign tax credit . Compare this amount, the tentative minimum tax (TMT), with the regular tax. If the TMT is greater than the regular tax, the result is known as the AMT. Add this net amount to the regular tax to show the taxpayer’s new, and greater, tax liability for the year.
Several additional resources on the alternative minimum tax for individuals follow below:
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Fact Sheet on Alternative Minimum Tax (pdf file)
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The Alternative Minimum Tax for Individuals (pdf file)
Many happy returns, Roger
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