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Week of May 30, 2008 • Issue No. 006
This Week in the iNews:
▲ Planning 2008: Alternative Minimum Tax for Individuals
One of the most difficult continuing issues for middle to upper income taxpayers is the effect of the alternative minimum tax. Originally enacted to ensure that all taxpayers, especially high-income taxpayers, paid at least a minimum amount of federal income tax, in recent years, the AMT has impacted an increasing number of middle income taxpayers. Because the risk of AMT liability is so high and seems to increase each year, individual taxpayers may benefit from tax planning by timing their tax items, including deferring certain items and accelerating others.
General Explanation
The AMT generally imposes a minimum tax on taxpayers who have substantially lowered their regular tax liability by taking advantage of tax favored and preference items, including deductions, exemptions, and credits. The AMT system recalculates an individual's tax liability using a separate formula under which many of the otherwise available reductions to taxable income are disallowed. The alternative tax is then compared to the taxpayer's regular tax, and the higher amount must be reported as the tax due on the individual's return. The computations involved in determining whether a taxpayer is required to pay AMT are extremely complex. Given the complexity of the rules and the increasing numbers of individual taxpayers who are finding themselves subject to the AMT system, individuals may benefit from tax planning to minimize or eliminate AMT liability.
AMT Computation, Rates and Exemption Amount
A taxpayer's AMT for a tax year generally is the excess of the tentative minimum tax over the regular tax liability. To calculate the tentative minimum tax, the taxpayer must first determine alternative minimum taxable income (AMTI) and then subtract the AMT exemption amount. The difference is then multiplied by the appropriate AMT rate. The product of this computation is the tentative minimum tax. The AMTI, as discussed below, is taxable income recomputed by taking into account adjustments and preferences.
The Tax Increase Prevention Act of 2007 provided for an increase in the AMT exemption amounts for tax years beginning in 2007. However, the exemption amounts have not kept pace with inflation. Consequently, more and more taxpayers are inadvertently subject to AMT. This has increased the need for effective AMT planning for individual taxpayers at even lower income levels.
Key Rates and Figures
AMT Exemption Amounts - 2007. The AMT exemption amount effective for tax years beginning in 2007, as increased by the AMT Relief Act, is:
• $66,250 for married individuals filing a joint return and surviving spouses;
• $44,350 for unmarried individuals other than surviving spouses; and
• $33,125 for married individuals filing separate returns.
Caution
AMT Exemption Amounts - 2008. Temporary legislative increases to the noncorporate AMT exemption amounts cease to apply in tax years beginning in 2008 and thereafter. Thus, barring further legislative action, the noncorporate exemption amounts that applied for tax years beginning in 2000 will again apply in tax years beginning after 2007. Thus, the exemption amounts for 2008 would be:
(1) $45,000 for married individuals filing a joint return and surviving spouses;
(2) $33,750 for unmarried individuals; and
(3) $22,500 for married individuals filing separate returns.
Exemption phase-out for 2007. Not all taxpayers potentially subject to the AMT are able to benefit from the AMT exemption amount; the exemptions are phased out as taxpayers reach high levels of AMTI.
Key Rates and Figures
The AMT rates are 26 percent on the first $175,000 ($87,500 for marrieds filing separately) of the taxable excess of tentative AMT over the regular tax, and 28 percent on amounts exceeding these levels.).
Alternative Minimum Taxable Income
AMTI is equal to a taxpayer's regular taxable income determined after a number of adjustments required and increased by certain tax preference items. AMTI generally is taxable income recomputed in a way that takes account of adjustments and preferences that are designed to eliminate the favorable tax treatment given to some items of income, deductions and exclusions under the regular tax.
Certain deductions otherwise available for computing taxable income are either not available to compute AMTI or are limited, including:
• Standard Deduction and Personal Exemption. The standard deduction and personal exemption are not allowed for AMT purposes.
• Itemized Deductions. Miscellaneous itemized deductions are not available for AMT purposes. The itemized deductions allowed for taxes, medical expenses and interest are more limited than for regular tax purposes. The limitation on itemized deductions for high income taxpayers does not apply in computing AMTI.
• Medical Expenses. The itemized deduction for medical expenses is allowable in computing AMTI only to the extent medical expenses exceed 10 percent of regular tax adjusted gross income rather than 7 1/2 percent of adjusted gross income. ().
• Home Mortgage Interest. The AMT allows a deduction for interest on mortgage borrowings used to buy, build, or improve the taxpayer's home. If funds are borrowed for another purpose, however, the interest deduction is not allowed under the AMT even if it would qualify as an itemized deduction.
l Employee Business Expenses. Employee business expenses reported on Form 2106, Employee Business Expenses, are work-related expenses not reimbursed in full by the employer. As miscellaneous itemized deductions, employee business expenses are not deductible for AMT purposes.
• State Taxes. Individuals may not claim an itemized deduction for the taxes described as state taxes. These taxes are:
(1) state, local, and foreign, real property taxes;
(2) state and local personal property taxes; and
(3) state, local, and foreign income taxes..
On Planning To Avoid Minimum Tax Liability
Perhaps the most important planning technique for taxpayers who are borderline candidates for the AMT is to do their best to maintain this situation. Bunching itemized deductions into one year causes the taxpayer to lose the value of these deductions in the regular tax year. If deductions are not evenly distributed, and the taxpayer has AMT and non-AMT years, the taxpayer should shift preference items from the AMT year to the non-AMT year until the taxpayer arrives at the brink of AMT liability, therefore reducing regular tax to the point where it equals the tentative tax. This technique provides the maximum benefit of preference deductions.
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