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Alternative Minimum Tax: Don’t End on a Bad Note

​Taxpayers may think of the income tax as a single computation.  However, there are two separate and distinct computations of which taxpayers must be aware.  The regular tax is just that, i.e. the “regular” computation.  Income is reduced by deductions, and tax is calculated from several marginal rates using the various tables. The alternative minimum tax (AMT) is closer to the flat tax that’s the subject of much political talk — a tax that’s based on income with fewer deductions and with a tax using one primary rate. 
 
For 2012, the maximum ordinary income tax rate is 35% while the maximum AMT rate is 28%.  While the lower AMT rate sounds attractive, the AMT is applied to a higher taxable income base because the calculation of alternative minimum taxable income (AMTI) is not reduced by certain deductions that reduce the regular income tax calculation.  See chart below.
 
 
Deductible​
Expense​ Regular tax
AMT 
State and local income tax ​ ​Y ​N
Property tax​ ​Y ​N
Mortgage interest​ ​Y ​Y
Home equity debt interest
(not used to improve your principal residence)​
​Y ​N
Investment interest​ ​Y ​Y
Professional fees​ ​Y ​N
Investment expenses​ ​Y ​N
Unreimbursed employee business expenses ​ ​Y ​N
Medical expenses​ ​Y ​Y
​Charitable contributions ​Y ​Y
 
 
AMT in Action
Let’s review how the AMT affects a “typical” taxpayer, Joe, with $1 million of income from wages and business income in 2012. For this example, our taxpayer is married, has two children, and has itemized deductions of $60,000 in state income taxes, $90,000 in property taxes, $50,000 of mortgage interest, and $50,000 of interest on a home equity line (used to purchase a new boat). For regular income tax, Joe will have taxable income of $735,000 ($1 million less $250,000 in expenses less $15,000 in exemptions) with an income tax due of $257,250 (reflecting a 35% tax rate). Joe’s alternative minimum taxable income is $950,000, reflecting a deduction for mortgage interest only, and an alternative minimum income tax due of $266,000, reflecting at AMT rate of 28%. Taxpayers in states with a high income tax and/or high property taxes are more likely to pay AMT.
 
When taxpayers are subject to AMT, they receive no benefit from state and local income taxes, property taxes, certain home equity debt interest, unreimbursed business expenses, or other items that receive preferential treatment for regular tax purposes.
 
While planning for AMT should always be considered, it’s especially important this year due to the potential for rising regular tax rates in 2013. The rising rates for regular tax, but not for AMT, will result in many taxpayers paying AMT in 2012 but not in 2013.  Moving a property tax bill to 2013 may be an effective tax-planning strategy if you’re in AMT in 2012 but not likely to be in AMT in 2013. Looking at the interaction of tax rates — and AMT status — is important in developing a comprehensive tax plan and avoiding unintended sour notes.
 
 
 
 
 
 

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