The election is over. For the next four years, our country will be led by President Obama. The White House placed their first “fiscal cliff” negotiations offer on the congressional table on Dec. 6th. The haggling over an agreement on the future of income tax rates, Medicare, payroll taxes, etc. continues, while American taxpayers try to remain optimistic that Congress will work collaboratively over the next 48 hours to develop a plan to create jobs, improve our economy and bring us out of the recession. However, since it’s our hard earned money that Congress is making decisions about, we need to keep informed regarding how our own financial situations may be impacted by potential congressional gridlock.
In our last blog, we discussed possible income tax hikes that could impact taxpayers if the extensions aren’t enacted by Dec. 31st. However, there is an obscure provision in the tax code, the “Alternative Minimum Tax” (AMT), that is about to affect approximately 30 million of middle class households’ pocketbooks, amounting to $3,700 in additional tax liability, on average. Many American taxpayers may not be aware of the AMT and that the patch may not be enacted. Approximately 26 million households that have not had to pay the AMT in the past may not be prepared to pay the additional tax when April 15th, 2013 comes around so it will benefit taxpayers to become informed.
WHAT IS THE AMT?
It is a parallel tax system that operates in tandem with the regular tax, expanding the amount of income that is taxed by adding items that are tax-free under the regular tax system and disallowing many deductions. It was originally created in 1969 to prevent the wealthiest taxpayers from using credits, deductions and other shelters to avoid taxes. Basically, it’s a flat tax with two tax brackets, including a 26% and a 28% bracket. However, since the AMT has not been indexed for inflation unlike income tax rates, which have been indexed, larger numbers of middle class taxpayers have been subject to the AMT.
WHY SHOULD TAXPAYERS BE AWARE OF THIS TODAY?
As part of the 2010 Tax Relief Act, Congress revised the exemption amounts used in making AMT computations for 2010. A patch was also enacted to decrease the number of taxpayers subject to the AMT in 2011 preventing their tax bills from increasing. However, the patch again expired at the end of 2011. While the White House and Congress are still in budget negotiations, the IRS has assumed that the patch will be enacted. If this does not come to fruition by year end, the IRS will be in a difficult position. They will need to make software programming changes and change the ordering rules that determine how tax credits are applied to regular income tax and AMT. This would require them to notify 60 million taxpayers that they may not file a tax return or receive a refund until late in March 2013 and possibly later.
For 2011, four million taxpayers were subject to the AMT with the following exemption amounts:
Single taxpayers: $48,450
Married taxpayers filing jointly $74,450
Married taxpayers filing separately $37,225
For 2012, 30 million taxpayers will be subject to the tax, with exemption amounts decreasing to:
Single taxpayers: $33,750
Married taxpayers filing jointly: $45,000
Married taxpayers filing separately: $23,500
Nationwide, one in five taxpayers will have to pay the AMT. For many taxpayers, such as a family of four, with two children and an income over $75,000, this will result in a much larger additional tax liability. IRS officials expect that taxpayers in more expensive, urban areas will be affected the most. The following
calculator can be used to project your income tax liability with various tax policies. http://calculator.taxpolicycenter.org/
Tax Policy Center
HOW DO I KNOW IF I AM SUBJECT TO AMT?
Complete IRS Form 6251 http://www.irs.gov/pub/irs-pdf/f6251.pdf to figure out if you owe anything under the AMT system. If the tax calculated on Form 6251 is higher than the amount owed on your regular income tax return, you’ll need to pay the difference as AMT.
WHAT CAN I DO TO REDUCE THE AMOUNT OF AMT I OWE?
Understanding the differences between regular income tax and the AMT is the first step in reducing your tax liability. The AMT has a completely different set of calculations than the regular tax. For the regular tax, you add up your total income, subtract out various deductions and personal exemptions, then calculate the tax. Against the regular tax you can claim various credits to reduce your tax even further. The AMT, however, does not allow the standard deduction, personal exemptions, or certain itemized deductions. Also some income which is not subject to the regular tax is added for AMT purposes. Your tax under AMT rules may be higher than your tax under regular tax rules.
When calculating the alternative minimum tax, various adjustments are made. Some income is added which is not subject to the regular tax. Some deductions are adjusted downwards or eliminated entirely.
The following items may trigger an AMT liability:
· Itemized deductions for state and local taxes, medical expenses, and miscellaneous expenses
· Mortgage interest on home equity debt
· Accelerated depreciation
· Exercising (but not selling) incentive stock options
· Tax-exempt interest from private activity bonds
· Passive income or losses
· Net operating loss deduction
· Foreign tax credits
· Investment expenses
This list is not comprehensive, but reflects the typical adjustments you should be aware of that can trigger an AMT liability. Typically, the alternative minimum tax eliminates most or exactly all of the regular tax savings from the above-mentioned deductions.
Devising tax strategies around the alternative minimum tax can be tricky, since the AMT often adjusts for various deductions and credits. Feel free to contact any of Holdsworth & Co.’s knowledgeable CPAs to answer any questions you might have regarding the AMT and how you might plan ahead to reduce your future overall tax liability.
We will be mailing our client’s tax organizers in the first half of January with your appointment times. If you are a potential client and would like to contact us to arrange an appointment, feel free to call us at 445-8633 or email us at firstname.lastname@example.org.