The Alternative Minimum Tax often is described as a "separate" tax system or a "parallel" tax system, separate and distinct from the "regular" tax system that applies to everyone. While the AMT creates a unique fraternity with a membership of over four million out of a total taxpayer population of over 150 million, there really is only one tax system in the U.S.
Our tax system is complicated, but the underlying concept is basic:
* we pay taxes on a calculated number that is known as "taxable income"
* we arrive at taxable income by adding different sources of income and then subtracting a certain number of deductions
* not all income is subject to tax
* little of what we spend each year may be taken as a tax deduction
* we apply the appropriate tax rate to our taxable income
* the result is our individual share of the national tax burden.
This same concept applies for the AMT as it does for the Regular Tax, but the individual components of the computation are different:
* more income is taxed under the AMT than it is under the Regular Tax
* fewer deductions are allowed under the AMT than under the Regular Tax
The key to remember is that, under these alternative computations, the tax that will be due is the greater of the AMT or the Regular Tax. While this may not seem fair, and in many cases it isn't, that's just the way it is. One has no choice.
The bulk of the AMT "hit" comes from the deduction side - deductions that an individual is allowed to take for the Regular Tax but is not allowed to take for the AMT. Some deductions are not allowed at all for the AMT, while others are allowed, but to a lesser degree. The Regular Tax deductions that are not allowed at all for the AMT are:
* the standard deduction
* the deduction for personal exemptions
* the itemized deduction for state and local taxes
* interest on certain second mortgages or home equity lines of credit
* miscellaneous itemized deductions
The Regular Tax deductions that are allowed to a lesser extent for the AMT are:
* the itemized deduction for medical and dental expenses
* many business expenses such as depreciation, depletion, and research expenses, among others
On the income side, there are fewer differences. The key ones are:
* tax-exempt bond interest that is from a "private activity bond"
* income from the exercise of an "incentive stock option" ("ISO")
* state income tax refunds
It is important to note that tax planning opportunities exist for all of these AMT items. Each one is different, of course, but the planning generally falls into the following groupings:
* paying certain expenses that are AMT items in one year versus another
* choosing a different accounting method
* altering an investment strategy
* altering a financing strategy
Certain AMT items cannot be avoided in their entirety (property taxes, for example, at least while one owns a home), but because income and deductions and tax rates do not remain static from year to year, the AMT almost always can be reduced in part by moving the AMT item into a different year. Other AMT items, however, may be eliminated in part or in full if they are covered by one of the other tax planning strategies listed above. Thus, the essence of AMT planning is 1) first determining which items are causing the taxpayer to fall into the AMT, and then 2) taking the appropriate action to lessen, if not eliminate, the effect of each item.
Our tax system is complicated, but the underlying concept is basic:
* we pay taxes on a calculated number that is known as "taxable income"
* we arrive at taxable income by adding different sources of income and then subtracting a certain number of deductions
* not all income is subject to tax
* little of what we spend each year may be taken as a tax deduction
* we apply the appropriate tax rate to our taxable income
* the result is our individual share of the national tax burden.
This same concept applies for the AMT as it does for the Regular Tax, but the individual components of the computation are different:
* more income is taxed under the AMT than it is under the Regular Tax
* fewer deductions are allowed under the AMT than under the Regular Tax
The key to remember is that, under these alternative computations, the tax that will be due is the greater of the AMT or the Regular Tax. While this may not seem fair, and in many cases it isn't, that's just the way it is. One has no choice.
The bulk of the AMT "hit" comes from the deduction side - deductions that an individual is allowed to take for the Regular Tax but is not allowed to take for the AMT. Some deductions are not allowed at all for the AMT, while others are allowed, but to a lesser degree. The Regular Tax deductions that are not allowed at all for the AMT are:
* the standard deduction
* the deduction for personal exemptions
* the itemized deduction for state and local taxes
* interest on certain second mortgages or home equity lines of credit
* miscellaneous itemized deductions
The Regular Tax deductions that are allowed to a lesser extent for the AMT are:
* the itemized deduction for medical and dental expenses
* many business expenses such as depreciation, depletion, and research expenses, among others
On the income side, there are fewer differences. The key ones are:
* tax-exempt bond interest that is from a "private activity bond"
* income from the exercise of an "incentive stock option" ("ISO")
* state income tax refunds
It is important to note that tax planning opportunities exist for all of these AMT items. Each one is different, of course, but the planning generally falls into the following groupings:
* paying certain expenses that are AMT items in one year versus another
* choosing a different accounting method
* altering an investment strategy
* altering a financing strategy
Certain AMT items cannot be avoided in their entirety (property taxes, for example, at least while one owns a home), but because income and deductions and tax rates do not remain static from year to year, the AMT almost always can be reduced in part by moving the AMT item into a different year. Other AMT items, however, may be eliminated in part or in full if they are covered by one of the other tax planning strategies listed above. Thus, the essence of AMT planning is 1) first determining which items are causing the taxpayer to fall into the AMT, and then 2) taking the appropriate action to lessen, if not eliminate, the effect of each item.
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