What are the top ten factors that trigger the AMT tax?
The alternative minimum tax (or AMT tax) is an additional tax that taxpayers have to pay in addition to the regular income tax. The purpose of the AMT tax was to prevent taxpayers with very high incomes from using the available tax loopholes and certain tax credits to either pay no or very little income taxes. Actually the IRS best described the purpose of the AMT tax as an attempt “to ensure that anyone who benefits from these tax advantages pays at least a minimum amount of tax.” Hence, Congress was very keen to implement the AMT tax as it was one mechanism available to impose a minimum tax liability on the so called high income taxpayers.
The AMT taxes are triggered by many factors or the so called Tax Preference Items but the following represent some of the top ten Tax Preference Items that seem to affect over 90% of the individual taxpayers. These are discussed in detail below.
It seems incredible that personal exemptions may result in a potential AMT tax liability. Thus, the more exemptions that are claimed the more likely that the taxpayer may be subject to wrath of the AMT tax. This is because the exemptions claimed for regular tax computation are not allowed when calculating alternative minimum tax. But it is quite rare that the personal exemptions by itself will trigger the imposition of the AMT tax.
2.State and Local Income Taxes
A taxpayer who itemizes on his tax return would generally be claiming a deduction for the state and local taxes along with the sales and property taxes. These deductions are allowed for the regular tax computation, whereas, these deductions are not allowed for the AMT calculation. A taxpayer who resides where state and local taxes are particularly high, would definitely be more likely to be subject to the alternative minimum tax.
3.Medical and Dental Expenses
Although medical and Dental expenses are allowed (subject to the 7.5% AGI limit) under the regular income tax calculation, however, for the AMT tax calculation, all or part of these medical or dental expenses may be disallowed, triggering a possible AMT tax liability.
4.Long Term Capital Gains
A taxpayer who has a very large long term capital gains may trigger the AMT tax, as this amount contributes to a reduction or elimination of the allowable AMT exemption (that is currently $44,350 for single taxpayer and $66,250 if married filing jointly or qualifying widow(er)and $33,125 if married filing separately).
5.Exercise of Incentive Stock Options
Generally speaking, an exercise of a large incentive stock option will not result in any regular income tax, but it is very likely to trigger the AMT tax.
The interest that is “exempt” from being taxed at the regular income tax may be subject to the AMT tax. It is worth noting that not all tax-exempt interest from Bonds is subject to the AMT tax. But, the interest from Bonds that are subject to the AMT tax may provide a slightly higher rate of interest to provide some compensation for the additional AMT tax.
7.Miscellaneous Itemized Deductions
The miscellaneous itemized deductions, that are claimed on schedule A, and include items such as tax preparation fees, investment fees and unreimbursed employee expenses are not allowed a deduction for AMT tax purposes. Clearly, a large deduction for miscellaneous itemized deduction would certainly lead the taxpayer to be subject to the AMT tax.
8.Interest on Second Mortgages
Though a deduction for interest on mortgage loan that is used to buy, build or improve your home is allowed for the AMT, if the taxpayer borrowed against a home for some other purpose, the interest deduction is not allowable for AMT, resulting in a potential AMT tax liability.
There are certain tax credits that are allowed for the regular income tax computation, but for AMT tax purposes these tax credits will be disallowed. Some of the tax credits that would be disallowed for AMT tax calculation are as follows:
• Any general business credit claimed on Form 3800
• Qualified electric vehicle credit
• Alternative motor vehicle credit
• Alternative fuel vehicle refueling property credit
• Credit for prior year minimum tax
Under the new method of depreciation called the Modified Cost Recovery System, (MACRS) taxpayers can accelerate their cost recovery. This method would provide a much faster cost recovery or depreciation when compared under the regular method.
For AMT tax purposes only the regular method of depreciation is allowed, and the difference between the regular method and the MACRS method is a Tax Preference Item and subject to the AMT tax.