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Measuring a Taxpayer's Vulnerability to the AMT It is not always easy or fun to calculate whether a given taxpayer will be subject to the alternative minimum tax (AMT). This article can be used for 2000 returns to determine quickly whether the AMT will apply to a given client situation. Stephen
Jolly, Ph.D, CPA Jack
Cathey, Ph.D, CPA Howard
Godfrey, Ph.D, CPA For more information about this article, contact Dr. Godfrey at (704) 687-4478 or Hgodfrey@email.uncc.edu .
Executive Summary
Taxpayers often need to determine whether a proposed transaction will trigger alternative minimum tax (AMT) liability.1 This article provides a framework for making this determination for 2000 without resorting to detailed computations.2 AMT preference and adjustment (AMT-P&A) limits are provided for a wide range of taxable incomes (TIs). An AMT-P&A limit is the maximum preferences and adjustments a taxpayer can have without incurring AMT, before considering tax credits. For joint returns with TI in the $40,000–$290,000 range, the AMT-P&A limit generally ranges from $27,000–$35,000.
The AMT System Congress determined long ago that some taxpayers could reduce their tax liabilities to an unacceptably low level under the regular tax system; thus, it created the AMT in the Revenue Act of 1978. The AMT is a separate tax system; the tax is based on modified rules for income, deductions, rates and credits. Under Sec. 55(b), a tentative minimum tax (TMT) is computed. Sec. 55(a) defines AMT as the excess of TMT over the regular tax for the year.
Computation For 2000 returns, Sec. 1 imposes income tax at a 15% rate on TI up to $43,850 on a joint return. The rate is 28% on TI from $43,850–$105,950, with higher rates applying to TI above $105,950.3 Sec. 55(b)(2) defines alternative minimum taxable income (AMTI) as TI (1) increased for tax preferences and (2) increased or decreased for certain adjustments.4 Under Sec. 55(b)(1), TMT is computed by applying the AMT rates to the "taxable excess" (AMT base). The AMT base is computed by subtracting the allowable AMT exemption from AMTI. Thus, the AMT computation formula is as follows:
A 26% AMT rate applies to an AMT base up to $175,000 on a joint return; a 28% rate applies to the portion of the AMT base over $175,000. The 26% AMT rate is 11% higher than the 15% lowest regular tax rate (RTR); however, Sec. 55(d)(1) provides an AMT exemption of $45,000 on a joint return, $33,750 on a single or head of household (HOH) return and $22,500 on a separate return. The exemption phases out at higher AMTI levels.
AMT Exemption Phaseout Range Sec. 55(d)(3) provides for a phaseout of the AMT based on AMTI and filing status. On a joint return, for example, the $45,000 exemption is reduced by 25% of AMTI in excess of $150,000. The phaseout range extends from $150,000– $330,000 on a joint return. Sec. 55(d)(1) provides for a single AMT exemption of $33,750, reduced by 25% of AMTI in excess of $112,500. Separate returns have a $22,500 AMT exemption, reduced by 25% of AMTI in excess of $75,000. An HOH return has a $33,750 exemption, reduced by 25% of AMTI in excess of $112,500.
Exemptions and Deductions Sec. 151 allows deductions for personal and dependency exemptions ($2,800 each in 2000). Sec. 63(c) provides a standard deduction of $7,350 on a 2000 joint return. Exemptions and the standard deduction are allowed when computing TI, but Sec. 56(b)(1) disallows them in calculating AMTI. Under Sec. 56(b)(1), many itemized deductions are disallowed in computing AMTI. As was noted, a $45,000 AMT exemption is allowed on a joint return, unless phased out. For a taxpayer with moderate income, the AMT exemption is likely to offset the negative effects of the: 1. Loss of personal and dependency exemptions. 2. Loss of the standard deduction or of a substantial part of itemized deductions. 3. Other AMT adjustments and preferences. 4. AMT rate higher than the RTR. 5. Loss of most credits when computing AMT.
Effect of Differences in Exemptions and Rates If tax rates were the same for both regular tax and AMT, a taxpayer filing jointly with AMTI below the exemption phaseout threshold would not be subject to AMT, unless AMT-P&A exceeds the AMT exemption. AMT-P&A includes personal exemptions and the standard deduction (or disallowed itemized deductions) claimed for regular tax purposes. Taxpayers with TI solely in the 15% bracket can incur AMT even if the AMT base is less than TI. See Example 1. Effect of AMT Rules on Higher-income Taxpayers When working with a high-income taxpayer, the causes for incurring AMT differ from the preceding example. Such a taxpayer will be in a regular tax bracket equal to (or higher than) the top 28% AMT rate. The taxpayer will incur AMT (before credits) only if the AMT base is higher than TI. A high-income taxpayer has the following characteristics that push the AMT base above TI: 1. The AMT exemption ($45,000 on a joint return) may be lost due to the phaseout. 2. The taxpayer is more likely to have a variety of types of income, some of which is tax-free for regular tax purposes, but taxable for AMT purposes (e.g., exercise of incentive stock options). 3. The taxpayer is likely to be claiming large deductions that are substantially disallowed in the AMT computation. These changes mean that the AMT base may be much larger than TI.
AMT P&A Limit Once TI is determined, the maximum AMT-P&A that can be realized without triggering AMT can be computed.
The above data are extended over a broader range of TI amounts in Exhibits 1 (for joint returns) and 2 (for single returns). Using these charts, a tax adviser can refer to projected TI to determine the maximum AMT-P&A the taxpayer can "afford" without incurring AMT.
Pattern of AMT-P&A Limits As income rises from zero to approximately $300,000 on a joint return, there are seven "inflection points" at which the AMT-P&A limit changes (see Exhibit 1): 1. Change from 15% to 28% RTR. 2. Change from 28% to 31% RTR. 3. Begin phaseout of the AMT exemption. 4. Change from 31% to 36% RTR. 5. Change from 26% to 28% AMT rate. 6. Change from 36% to 39.6% RTR. 7. End of AMT exemption phaseout. Change from 15% to 28% RTR: Joint filers with zero TI can have AMT-P&A of $45,000 (i.e., the AMT exemption) without incurring AMT. The limit on AMT-P&A declines as TI rises through the 15% regular tax range. In this range, the 26% AMT rate is higher than the 15% RTR. Additions to TI correspondingly increase the AMT base. This relationship causes the AMT-P&A shielded from the AMT by the exemption to decrease as TI increases. When TI passes $43,850, joint taxpayers move into the 28% RTR, but remain in the 26% AMT rate. A joint return with TI of $43,850 can have AMT-P&A of $26,448 without incurring AMT. As TI rises above $43,850, regular tax before credits rises faster than AMT before credits. Because there is little difference between the two tax rates, the line is nearly flat in this range. Change from 28% to 31% RTR: When TI reaches $105,950, joint taxpayers move into the 31% RTR, but remain in the 26% AMT rate. A joint return with $105,950 TI can have AMT-P&A of $31,225 without incurring AMT. Beyond this point, regular tax before credits rises faster than AMT before credits, resulting in an increase in the slope of the line. An additional dollar of TI generates additional regular tax of 31 cents and additional TMT of 26 cents. Accordingly, an additional dollar of TI results in a higher AMT-P&A limit. Begin AMT exemption phaseout: When AMTI reaches $150,000 ($116,707 TI + $33,293 AMT-P&A), phaseout of the AMT exemption begins. The phaseout increases the AMT base by $1.25 for each $1 of additional TI, preference or adjustment. In this range, the effective AMT rate of 32.5% exceeds the regular tax rate of 31%, resulting in a downward slope. Change from 31% to 36% RTR: When TI reaches $161,450, joint filers move into the 36% RTR. A joint return with $161,450 TI can have $31,229 AMT-P&A without incurring AMT. Beyond this point, the RTR exceeds the effective AMT rate of 32.5%, causing an increase in the slope of the line. Change AMT rate from 26% to 28%: The AMT rate changes from 26% to 28% when the AMT base reaches $175,000. In this range, the effective AMT rate (28% + effect of exemption phaseout) is 35%, very close to the 36% RTR. This leads to a relatively flat line of AMT-P&A limits. Change from 36% to 39.6% RTR: When $288,350 TI is reached, the marginal RTR changes from 36% to 39.6%. A joint return with $288,350 TI can have $35,806 AMT-P&A without incurring AMT. Beyond this point, there is a larger gap between the RTR and the effective AMT rate, resulting in a steeper slope. End of AMT exemption phaseout: The final event that affects the slope of the line is the completion of the AMT exemption phaseout at $293,515 TI ($36,485 AMT-P&A 1 $293,515 TI 5 $330,000, the upper limit of the phaseout range). By completing the phaseout (at a 25% rate), the effective AMT rate is reduced by 7% (back to the 28% nominal rate). This increases the difference between the AMT rate and the RTR by 7%. In this range, the RTR is 39.6%, while the AMT rate is 28%, resulting in a dramatic increase in slope.
Summary of AMT Pattern The AMT-P&A limit on a joint return is $45,000 at TI of zero. The AMT-P&A limit declines to $26,448 as TI reaches $43,850, the point at which the RTR increases from 15% to 28%. The AMT-P&A limit stays between $26,448 and $36,485 as TI rises from $43,850 to approximately $293,515. Beyond that level, the limit rises sharply. For TIs above $293,515, the 39.6% RTR is 11.6% higher than the 28% AMT rate. This creates a growing gap that can be filled with AMT-P&A, without incurring the AMT. A joint return with $380,000 TI can have $90,180 AMT-P&A without incurring AMT (see Exhibit 1). On a 2000 joint return, two personal exemptions and the standard deduction total $12,950. Under Sec. 56(b)(1), these items are AMT adjustments added back to TI in computing AMTI.5 After considering these ad-justments, the remaining AMT-P&A limits are in the $13,000–$24,000 range, for taxpayers with TI between approximately $43,850–$292,000. A taxpayer who itemizes will find that many itemized deductions are AMT adjustments under Sec. 56(b)(1). Key regular tax items (e.g., exemptions, tax brackets) are adjusted annually for inflation; however, key AMT items (e.g., exemption, phaseout range, tax rates) are not. Thus, the line on the chart will shift downward for each passing year in which there are inflation adjustments.
Single Returns AMT-P&A Limits As with the other types of filing status, a single return triggers the seven inflection points previously identified (see Exhibit 2). The initial AMT-P&A limit is $33,750 (the AMT exemption) at zero TI. The AMT-P&A limit declines as TI reaches $26,250, when the 28% RTR is reached. A single return with that TI can have AMT-P&A of $22,644 without incurring AMT. The AMT-P&A limit increases as TI rises through the 28% tax bracket range. When TI reaches $63,550 (start of the 31% tax bracket), the slope of the line increases. On a single return, (1) the AMT exemption is $33,750 and (2) the phaseout range starts at $112,500 AMTI and ends at $247,500. The inflection point for the start of AMT exemption amortization is reached at $83,207 TI and AMT-P&A of $29,293 (total $112,500). The slope stays down, until the 36% RTR is reached at $132,600 TI; the RTR then exceeds the effective AMT rate. At TI of $159,582, the AMT rate increases from 26% to 28%. When the exemption phaseout is considered, the effective AMT rate is actually 35%, almost equal to the 36% RTR. This proximity of rates leads to a relatively flat line until the next inflection point is reached. For a single return, the upper end of the AMT exemption phaseout range is reached when AMTI reaches $247,500. In Exhibit 2, this point is found at $215,970 TI with $31,531 AMT-P&A, a total of $247,500. Unlike a joint return, a single return involves a complete phaseout of the AMT exemption before reaching the top RTR at $288,350 TI. As with joint returns, AMT-P&A limits rise sharply once TI is at the 39.6% RTR.
Summary of AMT Pattern On a single return, the line for AMT-P&A limits follows the same general pattern seen for joint returns, rising sharply after the AMT exemption phases out and the top RTR is reached. The AMT-P&A limit on a single return is $33,750 at TI of zero. The limit declines to $22,644 as TI reaches $26,250 and the RTR increases from 15% to 28%. The AMT-P&A limit stays between $22,644 and $31,531 as TI rises from $26,250 to $215,970, when the exemption phaseout is complete. Beyond that level, the limit rises sharply. For TIs above $288,350, the RTR of 39.6% is 11.6% higher than the AMT rate. This creates a growing gap that can be filled with AMT-P&A without incurring AMT.
Separate Returns AMT-P&A Limits Taxpayers filing separately encounter the same seven inflection points identified earlier. A separate return involves a $22,500 AMT exemption; the phaseout starts at $75,000. The thresholds for the first four income tax brackets are only half as large as on a joint return. The AMT rate changes from 26% to 28% at an AMT base of $87,500. On a separate return, the line for AMT-P&A limits follows the same general pattern as for joint returns, rising sharply after the AMT exemption phases out and the top RTR is reached. The AMT-P&A limit on a separate return is $22,500 at TI of zero. The limit declines to $13,224 as TI reaches $21,925 and the RTR increases from 15% to 28%. The AMT-P&A limit stays between $13,224 and $17,903 as TI rises from $21,925 to approximately $144,175, when the top RTR is reached. At $146,757 TI (and $18,242 AMT-P&A, for AMTI of $165,000), the AMT exemption phaseout is complete. Once AMTI passes $165,000, the taxpayer encounters an adjustment unique to separate returns. Sec. 55(d)(3) requires that AMTI be increased by the lesser of $22,500 or 25% of the excess of AMTI over $165,000. This 25% add-on stops at AMTI of $255,000, which corresponds to $226,303 TI and a related $28,697 AMT-P&A limit. This causes the effective AMT rate to remain at 35% until AMTI reaches $255,000. Beyond TI of $226,303, the AMT-P&A limit rises sharply, because the 39.6% RTR is 11.6% higher than the 28% effective AMT rate. This creates a growing gap that can be filled with AMT-P&A without incurring AMT.
HOH Returns AMT-P&A Limits An HOH return involves an AMT exemption of only $33,750; the phaseout starts at $112,500. The AMT-P&A limit on such a return is $33,750 at TI of zero. The limit declines to $18,879 as TI reaches $35,150 and the RTR increases from 15% to 28%. The AMT-P&A limit stays between $18,879 and $24,039 as TI rises from $35,150 to $223,461, at which point, the AMT exemption completely phases out. At TI of $288,350, the top 39.6% RTR is reached. An HOH return with $288,350 TI can have $42,579 AMT-P&A without incurring AMT. Beyond that level, the AMT-P&A limit rises (see Exhibit 3).
Conclusion The AMT-P&A limit is the maximum amount of preferences and adjustments a taxpayer, with any given level of TI, can have without having to pay the AMT. Although AMT computations can be quite complex, the AMT-P&A limit has a predictable pattern vis--vis TI. For all four filing statuses, there are three distinct ranges (see Exhibit 3). In the first range, the AMT-P&A limit begins at an amount equal to the AMT exemption at TI of zero, and falls as TI increases in the 15% regular tax bracket. The second range begins when TI rises to the 28% bracket; the AMT-P&A limit begins to rise. In the second range, the line's slope tends to increase as increases in income drive the taxpayer into higher RTRs. The slope is also affected by changes in key AMT factors, such as the point at which (1) the AMT exemption phaseout begins, (2) the AMT exemption phaseout is completed and (3) the AMT rate increases from 26% to 28%. The second range covers the vast majority of individual returns filed; in that range, there is a relatively small variation in the AMT-P&A limits. The third range covers taxpayers with high TI. In this range, the AMT-P&A limit increases rapidly as TI increases, because the RTR increases to 39.6% in this range. When using the charts in this article, it is not necessary to perform all of the calculations for a projected return to determine whether a particular tax planning alternative will result in additional AMT liability. If TI for the current year can be predicted, the AMT-P&A that can be reported without incurring AMT can be determined by referring to the appropriate chart in this article.6 For any filing status, the AMT-P&A limit varies within a somewhat narrow range, until the top RTR is reached and the AMT exemption phases out. This should significantly reduce the time needed to make many tax planning decisions. |
