For years, like a worn-out record, Congress repeatedly went through the motions of temporarily patching the alternative minimum tax (AMT), with the goal of limiting the number of taxpayers who were liable to pay it. Fortunately, a law signed at the beginning of 2013 made the AMT patch permanent. But even with the patch, many taxpayers will fall into the AMT “trap.”
What triggers the AMT?
The AMT is a separate tax system with its own set of rules. You must calculate your tax under both the regular and AMT methods and then pay the higher amount. Certain deductions, credits, exclusions and other benefits that are allowed to reduce your regular income tax aren’t allowed for the AMT. The AMT calculation starts with regular taxable income and then adds back those disallowed items.
Some of the most common AMT triggers include:
- State and local income tax deductions (especially if you live in a high-income-tax state),
- Long-term capital gains and dividend income,
- Real estate and personal property tax deductions,
- Accelerated depreciation adjustments and related gain or loss differences when assets are sold,
- Large amounts of certain itemized deductions, and
- Tax-exempt interest on certain private-activity municipal bonds.
In certain situations, exercising incentive stock options can also trigger significant AMT liability.
What is the AMT patch?
The AMT patch is an exemption that reduces the amount of AMT income that’s subject to the AMT. The new tax law sets higher exemptions permanently. It also calls for annual inflation adjustments to both the exemptions and the AMT brackets. The exemption amount varies according to your filing status. For 2013, it’s $51,900 for single filers and heads of household and $80,800 for joint filers.
Many taxpayers receive a reduced AMT exemption amount due to a phaseout based on income. For joint returns in 2013, the phaseout starts at $153,900 of AMT income and is fully eliminated at $447,100. For those filing as singles or heads of households, the exemption is phased out between $115,400 and $323,000 of AMT income.
How does the AMT credit work?
In limited situations you may get some relief in the form of the AMT credit. By paying the AMT in one year on deferral items, such as depreciation adjustments, passive activity adjustments or the tax preference on incentive stock option (ISO) exercises, you may be entitled to a credit in a subsequent year. In effect, this takes into account timing differences that reverse in later years. But the credit might provide only partial relief or take years before it can be fully used. Fortunately, the credit’s refundable feature can reduce the time it takes to recoup AMT paid.
To take advantage of the credit, plan for the AMT when anticipating significant transactions, such as selling off assets or exercising ISOs, as well as in your year end tax planning.
How should you plan going forward?
Knowing where you stand AMT-wise may allow you to adjust your income and deductions to minimize the tax. For example, if it looks like you’ll be subject to the AMT this year, consider postponing until next year payment of deductible expenses that aren’t allowed for AMT purposes and recognizing additional income this year to take advantage of the AMT’s lower maximum rate (28% vs. 39.6%).
Or, if you don’t expect to be subject to the AMT this year or next, consider accelerating deductible expenses into 2013. This will defer tax, which is usually beneficial. But if you expect to be in a higher tax bracket next year, the opposite approach may be beneficial.
Work with a pro
Even with the higher exemption amounts now permanent, it’s still critical that you be aware of the AMT’s tax impact. Consult your tax advisor. He or she can help you navigate the treacherous waters of the