Alternative minimum tax (ALTMIN) 101

[tryan]

Just did my annual visit to my accountant yesterday. So I peppered him with questions about ALTMIN. Here’s what I learned –

ALTMIN was designed to close tax loop holes the wealthy were exploiting. Idea is to calculate your taxes two ways if a given taxable threshold is met and have the taxpayer pay the higher tax. For 2006 this threshold is $62,500 for couples and $42,500 for singles. The ALTMIN tax rate is 26%.

Paying 26% sounds like a bargain when the highest rate is 35% … BUT when the ALTMIN rate is calculated several standard deductions are given back. Here’s a PARTIAL list of the standard deductions which are taxed under the ALTMIN calculation:

• ISO (incentive stock options)
• State and Local taxes
• Property taxes (primary residence and vacation homes)
• Dependents/Children
• Home Equity loan interest (if the $$ was not used for home improvements)

Twice I asked if any deductions from a schedule E are given back (e.g. rental property taxes or loan interest); twice he said “no”.

He went on to tell some funny/sad stories about dot-com “millionaires” who were taxed on options ($500k in one case) which were ultimately worthless and a guy with 14 kids who gets hit with ALTMIN every year.

 

[LOL!]

I used TurboTax to get a feel for how to avoid the AMT. In December, I plugged in my numbers and saw the taxes I owed. I had a choice of whether to take a bonus in December or in January. I had a choice of whether to pay property taxes in Dec, Jan or split between those months. I had a choice of how much money to donate to charity and when (in Dec or Jan). I had a choice about market timing rebalancing investments in Dec or Jan.

I ran TT much like a spreadsheet with various choices and was able to see what reduced AMT to $0 and what increased it. Then I acted accordingly. How many scenarios did your accountant run for you?

 

[audreyh1]

I pay AMT almost every year.

Why?

Because I often realize a large capital gain. I sell a chunk of company stock that I still own almost every year.

A lot of people don't realize that realizing a capital gain of >$40K (or maybe it is >$50K now for married) will push you into paying AMT, if otherwise you are paying at the 15% to 25% income tax bracket.

To me that doesn't seem fair. I mean - I'm paying the full capital gains taxes. Why should that mean I have to pay 26% on most of my non-cap-gains income?

So basically people with most of their income in the form of cap gains will be penalized with a higher rate on their non-cap-gains income.

Audrey

 

[d]

To me that doesn't seem fair

... you're correct, but "fairness" and "taxes" are mutually exclusive

 

[tryan]

How many scenarios did your accountant run for you?

Every year I paid ALTMIN was due to a large capitol gain (selling RE). So my senario was sell now OR never sell. Not much middle ground.

 

[audreyh1]

Every year I paid ALTMIN was due to a large capitol gain (selling RE). So my senario was sell now OR never sell. Not much middle ground.

Yeah - those are my options. Never sell, or sell ALL in one year. But I prefer to divest my company stock over several years whenever it reaches certain price targets.

Audrey

 

[Martha]

We have also paid AMT for the past several years for the same reasons, sale of capital assets. We sold rental property and as a result ended up paying much higher tax rates on our ordinary income. I am not sure if we will be in the same place this year as I don't think we had significant capital gains. The significance of the AMT rates is that they start at 26%, not 10% like ordinary income tax.

Fair, not fair, it depends on your point of view. Sometimes it doesn't seem very fair to me to tax capital gains at a rate lower than labor is taxed. But then again, you get taxed on the entire gain and you don't get to deduct inflation from those gains, so maybe capital gains should bear a lower tax rate.

If we are going to have AMT, it does seem fair to count capital gains when determing your AMT income.

Instead of AMT I think that we should just face the fact that higher income people should be paying higher taxes at higher rates and not be so sneaky about it.

 

[TromboneAl]

My recollection is the AMT was a publicity stunt by government in reaction to the news item of the day being the scandalous salaries that some CEO's were getting, but that because those CEO's had good tax people, it didn't even work.

And were the legislators so dumb that they hadn't heard of inflation?

 

[calmloki]

Yeah - those are my options. Never sell, or sell ALL in one year. But I prefer to divest my company stock over several years whenever it reaches certain price targets.

Audrey

Not sure I understand these statements - my assumption is that you are saying that by selling all real estate at once and taking the AMT hit all in one year future year's income from other work or investments (as long as it stays below AMT trigger points) is protected from AMT level taxation? But if income is going to bump one into AMT anyway then a property sale each year wouldn't result in any increased AMT over the sell all in one year plan, right?

 

[audreyh1]

Not sure I understand these statements - my assumption is that you are saying that by selling all real estate at once and taking the AMT hit all in one year future year's income from other work or investments (as long as it stays below AMT trigger points) is protected from AMT level taxation? But if income is going to bump one into AMT anyway then a property sale each year wouldn't result in any increased AMT over the sell all in one year plan, right?

Well non-cap-gain income doesn't "normally" bump you into AMT unless you have some large deductions or you exercised stock options.

By selling your major asset(s) all in one year for a large capital gain, you only pay AMT rate on your other income that same year. With no capital gains realized in subsequent years (because you sold it all already) you don't get bumped into the AMT rate.

Obviously there are other tax issues that can "bump" you into AMT.

Audrey