Advisor Insight

Shedding light on the dreaded alternative minimum tax


The alternative minimum tax may be the most reviled tax in the country, but it is almost certainly here to stay, say tax advisors. If you've been subject to it in the past, there's a good chance you will be again this year.

"There's nothing magical you can do to avoid the AMT," said Mike Campbell, a tax partner with accounting and financial advisory firm BDO USA. "If you live in a high-income-tax state, it's a fact of life."

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The Tax Policy Center, a joint venture between the Brookings Institution and the Urban Institute that focuses on tax policy issues, estimated that just under 4 million Americans were liable for some AMT payment in 2013. That's about 10 percent fewer than in 2011.

The reason has nothing to do with the AMT itself. Instead, it's due to the increase in the highest marginal tax rate to 39.6 percent, causing higher-income earners to pay more on their regular tax returns.

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The leading cause of people being liable for the AMT is the required add-back of deductions for state income and property taxes. Those taxes, deductible on regular federal tax returns, can't be deducted for the AMT calculation. Thus, high-tax states, such as New York and California, account for a large percentage of taxpayers who pay the AMT.

According to data from the Tax Policy Center, 762,000 Californians and 509,000 New Yorkers paid AMT in the 2011 tax year. They comprised 30 percent of the total number of taxpayers nationwide subject to the tax that year, even though the two states together account for only 18 percent of the U.S population.

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"If you're a middle-class homeowner in New York State, there's a good chance you're in the AMT," said Paul Gevertzman, a partner with accounting firm Anchin, Block & Anchin. "It's unfair, and it's not what was intended when the tax was created in the 1960s, but proposals to repeal the AMT never go anywhere."

The AMT was "fixed" two years ago, insofar as the exemption amount and the phaseout thresholds for the exemption were finally indexed for inflation as part of the American Taxpayer Relief Act. Up to that point, more than 20 million taxpayers annually faced the possibility of having to pay the AMT if Congress didn't approve a patch adjusting the exemption amount.

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The exemption for 2014 is currently $52,800 for single filers and $82,100 for married couples filing a joint return, and it is now permanently indexed for inflation.

The exemption begins to phase out on income over $115,400 and is fully phased out for taxpayers earning more than $323,000. The AMT tax rate is 26 percent on income up to $179,500 and 28 percent on income above that threshold.

While the add-back of state and local taxes is the biggest cause of taxpayers being subject to the AMT, there are other differences between the tax regimes that can trip people up. There is no standard deduction—currently $6,200—and no personal and dependent exemptions under the AMT, meaning taxpayers with large families could, perversely, be penalized.

Most miscellaneous itemized deductions are also not deductible for AMT purposes, and if they're significant enough, they can result in additional tax liability. That includes tax preparation fees, investment advisor fees and business expenses.

"Get your employer to reimburse business expenses, even if it means getting a lower salary," Gevertzman said.

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Under AMT rules, taxpayers can also not take accelerated depreciation on rental or business properties. If a taxpayer is going to be liable for AMT payment (if the AMT calculation is higher than their regular tax liability), it often doesn't make sense to take the accelerated depreciation deduction.

The person might have to pay the AMT in early years and then face a larger gain on the depreciated property down the road.

"Deferral and acceleration techniques not only don't help sometimes, but you can get whipsawed," Gevertzman said.

Virtually all of my clients pay the AMT. I tell them 26 percent isn't a bad rate relative to the rest of the world.
Tim Speiss
personal wealth advisor at EisnerAmper

Short of moving out of high-tax states, not having children or making less money, there isn't a lot that taxpayers can do to completely avoid the AMT.

In some cases, they shouldn't try, said Tim Speiss, a personal wealth advisor with accounting and advisory firm EisnerAmper. "Virtually all of my clients pay the AMT," he said. "I tell them 26 percent isn't a bad rate relative to the rest of the world."

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Speiss suggests the way to minimize the long-term effect of the AMT is to do multiyear calculations based on a taxpayer's expected financial situation. Some strategies—such as delaying the fourth-quarter payment of state taxes or recognizing income in one year vs. the next—can save overall taxes from a multiyear perspective.

If someone knows they face the AMT this year but are likely earning more income next year, it can make sense to accelerate income or defer deductions now and pay the 26 or 28 percent AMT tax rate.

"It's better than paying at the 39.6 percent rate," Speiss said.