Bob O'Brien
Head Instructor
bobrien@mywealth.com
The Alternative Minimum Tax (AMT) is something that baffles a lot of financial planner’s minds, never mind someone that is not a tax professional. It is a parallel tax system that is less favorable than the “regular tax system” and can cause you to owe more in taxes.
The Alternative minimum tax was designed to create a tax liability for wealthy people that were so tax savvy that they were not paying any taxes. There was a special Tax Reform Act created in 1969 to target these 155 high income households that owed no tax at all. The only problem was that they never adjusted this for inflation. Now millions of Americans are being hit with this tax and it has been the cause of much controversy.
This is a perfect example of how legislation passed 40 years ago has an unintended effect in the future.
Understanding, the AMT really well would be like trying to understand algebra from just reading words alone. It is generally just not going to happen. In order to really understand it, you have to roll up your sleeves and go through the forms (probably much more than once for most of us). Working with a tax advisor or quality tax computer program will help a lot!
Here are a couple of main points to keep in mind in regards to the AMT that will help you avoid getting “blind sided” with a huge tax bill.
1. Be careful with stock options. Incentive Stock Options (ISO’s) are subject to AMT but Non-Qualified Stock Options (NQSO’s) are not. It is also very important that you keep good records when exercising ISO’s because you may get a credit in later years and there is now a dual cost basis for this stock.
2. Large, Long Term Capital Gains. Although they are not directly subject to the AMT, they decrease your AMT exemption. This can easily cause a larger tax bill than assumed. The capital gain can be a stock, real estate, or a business. This is perfect example of how your tax return has a lot of moving parts.
3. State Income Tax and Property Tax are common causes for the AMT. Miscellaneous itemized deductions and Private Activity Municipal Bonds are also common factors that throw you into the AMT. There are a lot of things that are deductible and perhaps tax favored, but the net effect is what really counts. Generally you may owe more, but these rarely create a tax shock like points #1 and #2 can. Also check out an article I wrote on a similar topic. Why is my State Tax Refund… “Taxable”?
4. Don’t be fooled by all the noise. A lot of people’s heads spin when it comes to the AMT and when looking at some of the articles out there on the topic, I can see why. A lot of the articles demonstrate common, middle class people that had to pay THREE TIMES their salaries in taxes because of the AMT. This is really only going to happen when point #1 or #2 above are involved. I have prepared taxes for a lot of people that were in the AMT. Many of them had no idea, didn’t even notice and still got a refund when in the AMT.
In conclusion, the AMT has been politicized as a place in which you may have to hand over your “first born”. It can be confusing because there are a lot of moving parts and it is really just a parallel “add back” system. This is why there is really no one amount of income that automatically makes you exempt. It is really more a question of how many tax deductions and preference items you have.
On the other hand, you are not going to be blindsided as long as you do some tax planning before you exercise stock options or selling something that creates a large capital gain. Most people’s taxes don’t vary much from year to year. However, certain “life changing events” require planning to make certain that we have a good tax strategy (such as buying or selling a home, a business, retirement etc…). This is when you definitely want to do a tax projection yourself, or get one done by a professional.
Please e-mail me any artciles you would like to see written bobrien@mywealth.com and check out our courses!
Bob O’Brien
Sr. Instructor
