It’s AMT Time
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Along with holiday festivities, December offers you and your clients a couple of weeks to sort out tax-preparation plans. And for the average American that increasingly means planning for the alternative minimum tax (AMT).
You’ve heard it before: More and more Americans are getting caught in the AMT’s sticky web. The AMT was designed to make sure the very rich paid their fair share of taxes—under the AMT, certain deductions were eliminated, like state and local taxes, real estate taxes, miscellaneous itemized deductions and income on the exercise of incentive stock options. (For details, read about the AMT here.)
But, because inflation was not considered when developing this “second” tax system, an increasing number of middle-class taxpayers are getting hit with the AMT. Only about 19,000 people owed it in 1970, but, according to the Tax Policy Center, 3.6 million taxpayers paid the AMT last year, and the group projects that number will skyrocket to 31 million by 2010. Today, those who are most vulnerable to the AMT are individuals with income over $75,000 and some large deductions—i.e., several children, interest deductions from second mortgages, capital gains, high state and local taxes and incentive stock options.
First things first: It’s important that you do the calculations to determine whether your clients will qualify for the AMT in the coming year. (The IRS Web site features an “AMT Assistant” to help determine taxpayers’ exposure to the AMT.) If so, there are a number of strategies you can use to minimize your clients’ tax bills. Roger Stinnett, vice president and manager of tax and financial planning at City National Bank in California, says planning with the AMT in mind is almost the exact opposite of planning under the regular progressive tax system. “When you’re in a regular tax situation you want to defer income and accelerate deductions. But for the AMT you want to accelerate income and delay deductions.”
For example, individuals have historically paid certain taxes before Dec. 31 in order to use those payments as deductions, says Jon Chernila, partner at Chernila & Co., a CPA firm in Newport Beach, Calif. This strategy helps reduce federal taxable income under the regular tax system. But, because AMT calculations don’t allow deductions for early tax payments, taking this approach could result in a higher AMT calculation than the regular tax bill, thus forcing your client to pay the AMT. Instead, the client should save these tax-payment deductions for the following year—that way he will be less likely to have to pay the AMT, and the deductions can potentially be used for the following year’s income taxes.
When it comes to exercising stock options, the best strategy is something called the “tandem exercise.” Typically, stock options are taxed when they are exercised—in other words, a gain is registered by the owner of the options when the stock has been bought. But whereas nonqualified stock options are taxable under ordinary income taxes, qualified incentive stock options are only taxable under the AMT. So if your client plans to exercise a number of incentive stock options and that plan pushes the client into the AMT bracket, you might consider having the client simultaneously exercise enough nonqualified stock options to cover that AMT liability, thus pushing his regular income tax bill over the AMT bill. Ultimately, he would have to pay taxes on exercise of the nonqualified stock options anyway.
Another way to accelerate income in order to avoid the AMT is to realize short-term capital gains. Short-term capital gains are better than long-term gains because the former are taxed at the individual’s regular income-tax rate (whereas long-term capital gains are taxed at 15 percent). Chernila says the idea may seem counterintuitive, but the strategy is “very fact and client specific.” He adds, “There’s not a whole lot we can do about the AMT, but we have to just understand the framework.”
