Chapter 18: Alternative minimum tax.
The alternative minimum tax (AMT) is in essence an income tax system that runs parallel to the "normal" federal income tax system. It is intended to impose a tax on certain taxpayers who have taken advantage of certain tax deductions, such as state and local taxes, or "preferences," which are items the taxpayer is deemed to be receiving special tax treatment.
While many individual taxpayers are able to complete and file their tax returns by simply filling out Form 1040 and a few supporting schedules, an increasing number of taxpayers are unwittingly subject to the AMT. Often, the AMT is levied on taxpayers after the fact--that is, the IRS compiles the necessary information and lets the taxpayer know that he forgot to compute the AMT liability and pay the additional tax.
Individuals can determine if the AMT applies to them in a given year by preparing IRS Form 6251. Corporations are also potentially subject to the AMT and use IRS Form 4626 to see if the tax applies. These forms are generally not required to be included with the filing of the taxpayer's return if the AMT does not result in a higher tax liability.
Trusts and estates filing income tax returns may also be subject to the AMT. These entities complete Schedule I of Form 1041 to compute their exposure. Pass-through entities like partnerships and S corporations are not subject to the AMT. However, they are responsible for reporting the applicable adjustments or preferences to the partners or shareholders on their Schedule K-1s.
Only a handful of people are even aware of the existence of this separate tax system. Far, far fewer understand how it is determined. Awareness of the AMT has been growing as more taxpayers fall under its reach. On the other hand, anyone who advises others must constantly be aware of the potential AMT impact of any recommendations that they make.
It has been projected that 4.1 million taxpayers were subject to the AMT in 2007, which represents over four percent of all taxpayers. Without any changes to the current tax law, the number of AMT taxpayers will skyrocket. According to the Urban-Brookings Tax Policy Center, approximately 33 million taxpayers will be subject to the AMT in 2010. (1) That represents more than 3 out of 10 taxpayers.
HOW AMT IS DETERMINED FOR INDIVIDUALS
The AMT is assessed at a rate of 26% of alternative minimum taxable income (AMTI) up to $175,000 ($87,500 for married taxpayers filing separately) and 28% of AMTI exceeding that amount. (2) Preferential tax rates for long-term capital gains and qualifying dividends are also used in determining an individual's AMT. (3)
With a maximum tax rate of 28%, many taxpayers automatically (and incorrectly) assume that because they are in the 28%, 33%, or 35% tax bracket, the AMT could not possibly apply to them. How is it possible that the AMT would apply when my marginal tax rate is higher than the maximum AMT rate? The answer lies in how AMTI is computed. A myriad of add-backs and special tax rules lead the taxpayer to what could be a significantly higher taxable income for the AMT than is calculated for regular tax purposes.
AMTI is computed as follows:
1. Taxable income as computed on Form 1040 (4) PLUS OR MINUS
2. Adjustments to taxable income (discussed below) (5)
3. The amount of "preference items" (specified items, discussed below, on which the taxpayer is receiving preferential tax treatment) (6)
4. An exemption of up to (a) $70,950 for a married couple filing jointly, (b) $46,200 for a single taxpayer, or (c) $35,475 for a married individual filing separately. (7) These exemption amounts were increased by the American Recovery and Reinvestment Act of 2009 and apply to the 2009 tax year only. Without any future tax legislation, the exemption amounts for 2010 and beyond will revert to the 2000 amounts ($45,000, $33,750, and $22,500, respectively). These exemption amounts are not indexed for inflation, which is one reason why an increasing number of taxpayers are expected to be subject to the AMT.
The allowable exemption is reduced by 25% of the amount by which AMTI exceeds $150,000 for married taxpayers filing jointly, $112,500 for single taxpayers, and $75,000 for married taxpayers filing separately. (8) Thus, in 2009, the exemption is completely phased out for joint filers with AMTI in excess of $433,800. The complete phase-out amount for single filers is AMTI over $297,300 and $216,900 for married individuals filing separately.
Related to the phase-out of the exemptions is a provision for certain married individuals who file separate returns to increase their AMTI. In 2009, a married individual filing a separate return must increase AMTI by the lesser of (a) 25% of the excess of theAMTI over $216,900, or (b) $35,475. After 2009, a married individual filing a separate return must increase AMTI by the lesser of (a) 25% of the excess of the AMTI over $165,000, or (b) $22,500.9
5. Alternative Minimum Taxable Income
The tax rates are then applied to the taxpayer's AMTI to yield the "tentative minimum tax." If the tentative minimum tax computed under this formula does not exceed the taxpayer's regular tax, the AMT does not apply. If the computed tentative minimum tax exceeds the taxpayer's regular tax, the excess of the tentative minimum tax over the regular tax is the AMT that is added to the tax liability computed in the normal manner.
The following is a simplified example of the computation of the AMT:
Example: Assume Dr. and Mrs. Ginsburg file a joint return for 2009. They have two dependent children. Their regular tax was computed to be $26,544. (1) Their taxable income is $135,000 (2) Their AMT adjustments to taxable income are 30,000 (3) Their tax preference items total 57,000 $222,000 (4) Their exemption amount is $52,950 ($70,950-$18,000) ($18,000 = 25% x ($222,000-$150,000)) (52,950) (5) Their alternative minimum taxable income is $169,050 (6) Their tentative minimum tax is $43,953
The excess of the Ginsburgs' tentative minimum tax ($43,953) over their regular tax ($26,544) is $17,409. This amount becomes their alternative minimum tax liability and is added to their regular tax. They would therefore pay a total tax of $43,953.
HOW AMT IS DETERMINED FOR CORPORATIONS
Corporations were first made subject to the AMT with the imposition of the Tax Reform Act of 1986. Only S corporations and certain small corporations that qualify for an exemption are not subject to the AMT. In the case of S corporations, the adjustments and preferences are determined at the corporate level and are passed out to the shareholders on their Schedule K-1s each year.
The corporate AMT is assessed at a rate of 20% of "Final AMTI." If this tentative minimum tax exceeds the regular corporate tax, the excess is the AMT for the year.
A corporation's AMTI is determined as follows:
1. Taxable income (or loss) before any net operating loss deduction as computed on Form 1120 (10)
PLUS OR MINUS
2. Adjustments to taxable income (11)
3. The amount of "preference items" (12)
4. Pre-adjustment AMTI
5a. If the corporation's adjusted current earnings (ACE) exceeds Pre-adjustment AMTI, 75% of the excess of ACE over Pre-adjustment AMTI is added to Pre-adjustment AMTI to yield Post-adjustment AMTI. (13)
5b. If the corporation's ACE is less than Pre-adjustment AMTI, the lesser of the following amounts is subtracted from Pre-adjustment AMTI to yield Post-adjustment AMTI:
* 75% of the excess of Pre-adjustment AMTI over ACE (14) and
* the excess aggregate upward ACE adjustments for prior tax years over the aggregate downward ACE adjustments for prior taxable years. (15)
6. Any allowable Alternative Tax Net Operating Loss deduction
7. "Final AMTI"
8. An exemption up to $40,000.16 This exemption is phased-out by 25 cents for every dollar of the amount of the corporation's final AMTI exceeds $150,000.17 Therefore, at $310,000, the exemption is completely lost. Note that only one $40,000 exemption is allowed per group of controlled corporations. (18) The exemption is allocated evenly among the group members unless an election is submitted with the tax returns of the group. (19)
9. Corporate AMTI
The AMT tax rate for corporations of 20% is then applied to the corporation's AMTI to determine the tentative minimum tax. If the tentative minimum tax exceeds the corporation's regular tax, the excess is the AMT that is added to the corporation's regular tax.
ADJUSTMENTS AND PREFERENCES
A common misconception is that adjustments and preferences for AMT purposes are the same thing. In fact, adjustments and preferences are very different. Adjustments are defined under Code section 56 and are usually amounts that are determined separately for regular tax and AMT purposes. AMT adjustments may be positive or negative.
AMT preferences are defined under Code section 57 and result in an add-back to taxable income because of some "preferential" treatment received for regular tax purposes. Preferences may only result in an increase to taxable income. Negative preferences are not permitted.
Adjustments for Individuals and Corporations
The more common adjustments to taxable income that apply to both individuals and corporations include the following:
1. For property placed in service after 1986, depreciation deductions are adjusted to conform to special rules for the AMT. (20) Normally taxpayers follow the MACRS rules for determining their depreciation on fixed assets. For personal property, MACRS typically uses a 200 percent declining balance method for determining the annual expense. The applicable recovery period is determined by referring to Rev. Proc. 87-56 (21) and referring to the asset class of the property to be depreciated.
For property placed in service prior to 1999, taxpayers were required to re-compute their fixed asset depreciation using the 150 percent declining balance method and, in most cases, a longer recovery period. This led to potentially large positive adjustments for determining AMTI in the earlier years an asset was in service (i.e. higher AMTI) followed by negative adjustments in later years.
Example: ABC Corporation purchased $10,000 worth of furniture in 1998. The furniture has a 7-year life for regular tax purposes using the 200 percent declining balance method and a 10-year life for AMT using the 150 percent declining balance method. ABC's depreciation calculations are:
Regular AMT AMT Year Depreciation Depreciation Adjustment 1998 $1,429 $750 $679 1999 $2,449 $1,388 $1,061 2000 $1,749 $1,179 $570 2001 $1,249 $1,002 $247 2002 $893 $874 $19 2003 $892 $874 $18 2004 $893 $874 $19 2005 $446 $874 ($428) 2006 -- $874 ($874) 2007 -- $874 ($874) 2008 -- $437 ($437)
For property placed in service after 1998, taxpayers may use the same recovery period that is used for determining their regular tax depreciation. However, the depreciation method still may be no faster than the 150 percent declining balance method. (22)
Example: ABC Corporation purchased $10,000 worth of furniture in 1999. The furniture has a 7-year life for regular tax purposes using the 200 percent declining balance method and a 7-year life for AMT using the 150 percent declining balance method. ABC's depreciation calculations are:
Regular AMT AMT Year Depreciation Depreciation Adjustment 1999 $1,429 $1,071 $358 2000 $2,449 $1,913 $536 2001 $1,749 $1,503 $246 2002 $1,249 $1,225 $24 2003 $893 $1,225 ($332) 2004 $892 $1,225 ($333) 2005 $893 $1,225 ($332) 2006 $446 $613 ($167)
The Job Creation and Worker Assistance Act of 2002 added the concept of bonus depreciation for certain types of property. In short, 30% of qualifying property may be expensed in the year of purchase for assets purchases between September 11, 2001 and January 1, 2005.
JGTRRA 2003 increased the bonus depreciation to 50% for asset purchases on or after May 6, 2003 and before December 31, 2004. Taxpayers can elect 30% bonus depreciation, 50% bonus depreciation, or no bonus depreciation. The Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009 reinstituted a 50% bonus depreciation allowance for assets placed in service during 2008 and 2009. The bonus depreciation is allowed for both regular tax and AMT purposes. (23) In addition, the remaining basis of the qualified property is deductible for both regular tax and AMT. (24)
Example: ABC Corporation purchases $10,000 of furniture in June 2009. The furniture has a 7-year life for regular tax purposes using the 200 percent declining balance method and a 7-year life for AMT using the 150 percent declining balance method. The furniture also qualifies for a 50% bonus depreciation in the first year. ABC's depreciation calculations are:
Regular Tax AMT AMT Year Depreciation Depreciation Adjustment 2008 $5,715 $5,715 $0 2009 $1,224 $1,224 $0 2010 $875 $875 $0 2011 $624 $624 $0 2012 $447 $447 $0 2013 $446 $446 $0 2014 $446 $446 $0 2015 $223 $223 $0
2. Mining exploration and development costs, circulation expenditures, and research and development expense deductions must be adjusted to conform with special AMT amortization rules. (25)
3. Long-term contracts entered into after February 28, 1986 must be accounted for using the percentage-of-completion method for purposes of the AMT. (26)
4. The net operating loss (NOL) allowed under IRC Sec. 172 is added back to taxable income and replaced with the alternative tax net operating loss (ATNOL) deduction. (27)
A taxpayer that has a NOL in a year may also, but not necessarily, have an ATNOL. For this reason, a separate calculation must be performed to determine a taxpayer's ATNOL. This is done by starting with the NOL for regular tax purposes and increasing or decreasing this amount by the AMT adjustments and preferences in the year of the loss. (28)
Example: Jack determined that he had a NOL of $175,000, which was attributable to one year when his business fell on hard times. His only AMT adjustment in that year was a $15,000 positive depreciation adjustment. Since the positive depreciation adjustment increased his AMTI, it reduces his NOL by that amount to yield an ATNOL of $160,000.
The amount of ATNOL that can be claimed as a reduction to AMTI is limited to 90% of the taxpayers AMTI determined without regard to the ATNOL. 29 An exception was added by the Job Creation and Worker Assistance Act of 2002 for ATNOL carrybacks arising in and ATNOL carryforwards to tax years ending in 2001 and 2002. For such losses, the 90% limitation was increased to 100%. Note that an ATNOL must be initially carried to the same year as the regular tax NOL.
5. Gains or losses on the sale of property are adjusted to reflect the special depreciation rules used for AMT purposes. (30) Since the depreciable assets are expensed using potentially different method or life, the adjusted basis for AMT purposes may be different than it will be for regular tax purposes. As a result, when an asset is sold or otherwise disposed, the gain or loss must be recomputed using the asset's adjusted AMT basis.
Example: In 2003, TireWorld, Inc. sold a piece of furniture for $3,000. The company originally purchased for $10,000 in 1998. At the time of the sale, their adjusted tax basis in the asset was $1,785 for regular tax purposes and $4,370 for AMT. TireWorld correctly computes their regular tax gain as $1,215 ($3,000-$1,785). For AMT purposes, TireWorld realized a loss of $1,370 ($3,000-$4,370). TireWorld would report an "adjusted gain or loss" adjustment of negative $2,585, the difference between the adjusted basis in the asset for regular tax and AMT purposes.
Adjustments for Individuals
Certain adjustments that apply solely to individuals include:
1. No deduction is allowed for any miscellaneous itemized deduction as defined in IRC Sec. 67(b).31 Therefore, taxpayers with high investment expenses, tax preparation fees, un-reimbursed employee business expenses, etc. relative to their adjusted gross income may not receive a benefit from these expenses if the add back for AMT purposes causes them to be subject to the tax.
Example: Joe Grant retired in early 2009 and, as a result his AGI was $45,000, much lower than usual. He paid $1,500 to have his 2008 tax return prepared, $10,000 to his investment manager for managing his investment portfolio and incurred $5,000 of unreimbursed employee business expenses. All of these expenses combined exceed 2% of his AGI. Joe's itemized deduction schedule for 2009 will show that $7,500 of these expenses are deductible ([$1,500 + 10,000+5,000] -[$45,000 x 2%]). However, $7,500 will need to be added to his taxable income to determine his AMTI for 2009.
2. Any taxes that are claimed as an itemized deduction must be added back for determining AMTI. (32) A tax that is deducted as part of a trade or business (e.g. as a sole proprietor) is not an AMT adjustment. The taxes that must be added back include itemized deductions of state, local and foreign real estate taxes, state and local personal property taxes and state, local and foreign income taxes. If a taxpayer elects to deduct sales taxes instead of state and local income taxes (as currently permitted from 2004 through 2009), the full amount of the sales tax deduction must be added back in determining AMTI.
3. Medical expenses that exceed 7.5% of a taxpayer's adjusted gross income is allowed as an itemized deduction. (33) For the purpose of determining a taxpayer's AMTI, medical expenses are only deductible if they exceed 10% of the taxpayer's AGI as computed for regular tax purposes. (34)
Example: Sam Watson has adjusted gross income of $100,000 and medical expenses of $9,000. His deductible medical expense for regular tax purposes is $1,500 ($9,000-[$100,000 x 7.5%]). When computing AMTI, Sam must add back the entire $1,500 deduction since his medical expenses do not exceed 10% of his AGI ($10,000).
Example: Assume Sam's medical expenses are $12,000 instead of $9,000. His regular tax deduction is $4,500 ($12,000-[$100,000 x 7.5%]). His AMT deduction is $2,000 ($12,000 -[$100,000 x 10%]). The difference of $2,500 is the positive AMT adjustment that must be made in order to determine his AMTI.
4. Investment interest expense must be recomputed considering any adjustments or preference items that relate to total investment income or expense. (35)
5. Home mortgage interest on indebtedness that was not incurred to acquire, construct or substantially improve the taxpayer's principal residence or second home must be added back for computing AMTI (36). This would include home equity indebtedness if the proceeds of the loan were not used in the manner described above. Refinancing of previously qualifying indebtedness is allowed, but only to the extent of the amount of the qualifying indebtedness immediately before the refinancing. (37)
6. Refunds of taxes that were required to be added to AMTI under IRC Sec. 56(b)(1)(A)(ii) reduce AMTI in the year of receipt. (38)
7. If the taxpayer's taxable income was reduced by either the standard deduction or personal exemptions, these items must be added back for AMT purposes. (39)
8. Taxpayers may defer regular tax on income resulting from the exercise of an incentive stock option (ISO).40 Unlike nonqualified stock options which are taxed to the extent of the value of the stock over the exercise cost, the taxation of an ISO occurs only when the stock acquired by exercise of the ISO is sold or otherwise disposed. At that time, the difference between the selling price and the amount paid for the stock when the ISO was exercised is taxed as a capital gain.
The deferral of the gain at the time of the exercise of the ISO does not apply if the taxpayer disposes of the stock within two years from the grant date of the ISO or within one year of the exercise date of the option. (41)
For AMT purposes, the ISO does not receive the deferral treatment at the time of exercise. Instead the ISO is treated like a nonqualified stock option. (42) This means that the value of the stock acquired at the time of exercise in excess of the exercise cost creates a positive AMT adjustment in that year. Sizeable ISO exercises are a common reason for taxpayers to be subject to the AMT.
Taxpayers who exercise ISOs must keep accurate records of the basis of their stock. For regular tax purposes, the basis will equal their exercise cost plus any transaction costs. For AMT purposes, the basis will equal the value of the stock on the date of exercise plus any transaction costs. When the stock acquired by ISO is ultimately sold, the taxpayer will reduce the AMTI in that year by the amount of the basis difference.
Example: Ron Gardner exercised 1,000 ISOs of his employer, WWW, Inc. The exercise cost was $10 per option and at the time of the exercise, the stock was trading at $75 per share. Ron pays the company $10,000 and, in return, receives stock valued at $75,000. For regular tax purposes, Ron reports no income. However, he has a positive AMT adjustment of $65,000 ($75,000-10,000) in the year of exercise.
Example: Three years later, Ron decides to sell 500 shares when the stock is trading at $100 per share. He will report a long-term capital gain for regular tax purposes of $45,000 ([$100 x 500]-[$10 x 500]). For AMT purposes, his gain is only $12,500 ([$100 x 500]-[$75 x 500]). The difference in the gain of $32,500 results in a negative AMT adjustment (reported as an adjusted gain or loss on Form 6251) in the year of the sale.
9. Investments in flow-through entities are required to separately identify an amount that would need to be reported for AMT purposes by its investors. For this reason, it is very common to find AMT adjustments for depreciation reported on an investor's Schedule K-1.
Passive activity rules are separately applied for AMT purposes. If the net income or loss from passive activities as adjusted by any AMT items is different than the net passive activity income or loss for regular tax purposes, the difference is reported as an adjustment to AMTI. (43)
The following adjustments must be made to a corporation's taxable income:
1. A corporation must make an adjustment to its taxable income based on its "adjusted current earnings" (ACE). (44) A later section of this chapter explains the ACE computations in detail.
2. The charitable contributions limitation for individuals is determined based upon the taxpayer's adjusted gross income for both regular tax and AMT purposes. (45) However, corporations must re-determine their allowable charitable contribution for AMT purposes based upon the corporation's AMTI, without respect to this adjustment. (46) In fact, the instructions to Form 4626 require that this computation and adjustment be made if necessary.
The following tax preference items must be added to a taxpayer's taxable income in computing AMTI. As previously mentioned, tax preference items may only increase AMTI--negative tax preference items are not permitted.
1. The excess of the deduction for depletion over the adjusted basis of the property at the end of the taxable year. (47)
2. The amount by which excess intangible drilling costs are greater than 65% of the net income of the taxpayer's oil, gas, and geothermal properties for the tax year. (48)
The excess intangible drilling costs are the excess of the intangible drilling and development costs paid or incurred in connection with oil, gas and geothermal wells over the amount that would have been allowable for the taxable year if such costs had been capitalized and straight line recovery of intangibles (over 120 months) had been used with respect to such costs. (49)
3. Any tax-exempt interest earned on "specified private activity bonds" must be added to AMTI. The amount of interest to be added back is reduced by any deductions which would have been allowable if the tax-exempt interest was includible in gross income for regular tax purposes. (50)
A specified private activity bond is any private activity bond which is issued after August 7, 1986 (other than one issued during 2009 or 2010).51 Private activity bonds are covered by IRC Sec. 141 and include any bonds that meet either (1) the "private business use" test and the "private security or payment" test or (2) the "private loan financing" test.
A bond is identified as a private activity bond at the time of its issue. Because of the inclusion of the interest paid on such bonds in the AMTI of its holders, these bonds typically will pay a higher yield than pure tax-exempt municipal bonds.
Investors in mutual funds that earn some tax-exempt interest should watch for the percentage of tax-exempt income that was earned on private activity bonds. The proportionate share of the tax-exempt income earned on such bonds must be added to AMTI. (52)
4. Certain depreciation or amortization of assets placed in service prior to January 1, 1987 must be added back to compute AMTI. (53) The preference amount is the excess of the depreciation allowed for regular tax purposes over the depreciation that would have been claimed using the straight-line method with a half-year convention.
5. Gains of certain small business stock that is held for more than five years generally qualify for a 50% exclusion from taxation. (54) Small business stock must meet the following requirements:
a. It must have been issued after August 10, 1993. (55)
b. The taxpayer must be the original holder of the stock and the stock must have been acquired in exchange for money or other property (not including stock) or as compensation for services performed. (56)
c. The corporation must be an active business. (57)
d. The corporation must be a qualified small business. (58) That is, it must be a domestic C corporation with aggregate gross assets of less than $50,000,000. (59)
The amount of the excluded gain that must be added back to AMTI is 7%. (60)
Example: Jack Armstrong realized a gain of
$300,000 on the sale of Section 1202 stock on June 1, 2009. Accordingly, Jack excludes $150,000 of the gain for regular tax purposes. Jack must add back $10,500 ($150,000 x 7%) as a preference item when determining his AMT.
AMT EXEMPTION FOR SMALL CORPORATIONS
The Taxpayer Relief Act of 1997 created an exemption from the AMT for certain "small" corporations. The exemption applies to qualifying corporations with tax years beginning after 1997.
In order to qualify for the exemption, a corporation must look to its three taxable years prior to the taxable year in question. (61) The average gross receipts for this three-year period must not exceed $7.5 million. (62)
Example: Smallville, Inc. needs to determine if it can qualify for the AMT exemption in 2009. They expanded operations in the prior year and their revenue doubled. The company reviews their prior three years of revenue and find that for 2006, 2007, and 2008 their gross receipts were $6 million, $6 million, and $12 million, respectively. Their average gross receipts for the preceding three-year period is $8 million ([$6 + $6 + $12] h- 3). Therefore, Smallville no longer qualifies for the small corporation AMT exemption beginning in 2003.
A special exception applies for new corporations. Any first year corporation is automatically exempted from the AMT regardless of the amount of gross receipts derived from operations. (63) For a new corporation's second year, the exemption will only apply if the corporation's gross receipts in the first year were no more than $5 million. (64) After a corporation's second year, the corporation must meet the $7.5 million average gross receipts test. Gross receipts for any taxable period of less than 12 months must be annualized when applying these tests. (65)
If a qualifying small corporation ceases to be a small corporation because its average gross receipts exceed the allowable limits, the corporation will be subject to the AMT for that and all future years. The first day of the taxable year during which the taxpayer ceases to be a small corporation is the "change date." (66) The AMT is then computed with the following modifications:
1. The depreciation adjustment is computed only on property placed in service after the change date. (67)
2. The mining and exploration adjustment is applied only to costs paid or incurred after the change date. (68)
3. The long-term contract adjustment is applied only to contracts entered into after the change date. (69)
4. The adjustment for alternative tax net operating loss deduction must be computed by making adjustments to the NOL computation under IRC Sec. 56(d)(2) by substituting the change date for January 1, 1987 and the day before the change date for December 31, 1986 each place that it appears. (70)
5. The limitation on the allowance of negative adjustments to AMTI based on adjusted cur rent earnings will apply only to those "prior taxable years" that begin on or after the change date. (71)
6. The depreciation adjustment for computing ACE does not apply. (72)
7. The earnings and profits adjustment and depletion of IRC Sec. 56(g)(4)(D) and (F) apply as if the day before the change date were substituted for December 31, 1989 in each place it appears. (73)
THE ADJUSTED CURRENT EARNINGS ADJUSTMENT FOR CORPORATIONS
As mentioned in the formula for determining the AMT for corporations and the description of adjustments that apply to corporations when determining AMTI, there is an adjustment that must be made based on ACE--adjusted current earnings. ACE is defined as the AMTI for the taxable year determined with its own set of "ACE adjustments" and without the alternative tax net operating loss deduction. (74)
The adjustments that must be made to determine a corporation's ACE are:
1. Depreciation must be recomputed for ACE using a special set of rules for allowable method and recovery period. This makes potentially a third set of depreciation calculations on the same asset --one for regular tax, one for AMT and now one for ACE. An asset's placed in service date determines how the asset is treated for ACE. The adjustment applies to assets placed in service after 1989--however, assets in service as of 1989 also need an ACE calculation.
The following table is a summary of how assets are depreciated under the ACE rules:
Placed in ACE Depreciation Treatment Service Date Taxable year Basis for ACE depreciation beginning begins with AMT basis as before 1990 of the close of the last year (MACRS Assets) before 1990. Depreciate using straight line method over the remainder of the property's recovery period as determined under the alternative depreciation system. (75) Taxable year Basis for ACE depreciation beginning begins with regular tax basis before 1990 as of the close of the last (ACRS Assets) year before 1990. Depreciate using straight line method over the remainder of the property's recovery period as determined under the alternative depreciation system. (76) Taxable year No adjustment for ACE beginning required. (77) before 1990 (non-MACRS and ACRS Assets) Taxable year Straight-line recovery over beginning after the property's recovery 1989 and on period as determined under or before the alternative depreciation December 31, 1993 system. (78) After ACE depreciation computed December 31, 1993 in the same manner as AMT depreciation. (79)
2. The second ACE adjustment is for items that are included in the determination of a corporation's earnings and profits (E&P) but are excluded from AMTI. (80) The amount of any item that is included as an adjustment may be offset by any deduction which would have been allowable in computing AMTI if the amount were included in gross income. (81)
The ACE worksheet included in the instructions to Form 4626 contains a list of the most common E&P adjustments, such as:
a. Tax-exempt interest excluded under Code Section 103.
b. Death benefits from life insurance contracts excluded under Code Section 101 (adjusted by the corporation's basis in the life insurance contract).
c. Other distributions from life insurance contracts.
d. Income earned on life insurance contracts minus the part of any premium attributable to insurance coverage.
a. Deduction for dividends received, with certain exceptions for 100% dividend received deductions and dividends from a 20% owned corporation if the payor is subject to federal income tax on the earnings to which the dividend is attributable. (82)
b. Dividends paid on certain preferred stock of public utilities deductible under Code Section 247.
c. Dividends paid to an ESOP deductible under Code Section 404(k).
d. Nonpatronage dividends that are paid and deductible under Code Section 1382(c).
a. Intangible drilling costs on productive wells of integrated oil companies must be capitalized and amortized over 60 months. (83)
b. Amortization on circulation and organizational expenditures under Code Sections 173 and 248, respectively, is not permitted. (84)
c. For taxpayers that account for inventory on a last-in, first-out (LIFO) basis, the excess of inventory value on a first-in, first out basis over LIFO basis is an adjustment for ACE. (85)
d. The installment sale method is not permitted for ACE. (86) As a result, taxpayers with an installment sale will have a large adjustment in the first year followed by negative adjustments as payments are made on the installment sale in future years.
Adjustments are not required for discharge of indebtedness income under Code Section 108.87 In addition, the limit on charitable contributions is not recomputed for ACE. (88)
Once the corporation's ACE is determined, the ACE is compared to its pre-adjustment AMTI. If ACE exceeds pre-adjustment AMTI, the corporation must increase its AMTI by 75% of the excess. (89)
If ACE is less than pre-adjustment AMTI, the corporation may reduce its AMTI by 75% of the difference. (90) However, the potential negative adjustment is limited to the excess of the aggregate positive ACE adjustments made to AMTI in prior years over the aggregate negative ACE adjustments made to AMTI in prior years. (91)
FOREIGN TAX CREDIT
A credit for foreign taxes paid or accrued is permitted as a reduction to the tentative minimum tax for individuals and corporations. The credit is computed in the same manner as it is for regular tax purposes except it is based on the tentative minimum tax before the credit. Taxpayers claiming the credit must adjust taxable income by the adjustments and preferences of Code Sections 56, 57 and 58. (92)
CREDITS AGAINST REGULAR TAX
There are a number of credits that are available to reduce a taxpayer's regular tax liability. However, a taxpayer may be limited in the amount of credits that may be used to offset their regular tax liability based on the AMT for the year.
For 2009, an individual taxpayer's nonrefundable personal tax credits are allowed to offset both regular tax and AMT. (93) Nonrefundable personal credits are those that are defined under Internal Revenue Code Sections 21 through 26, which include:
1. Child tax credit
2. Education credits (Hope and Lifetime Learning Credits)
3. Child and dependent care credit
4. Adoption credit
5. Credit for interest paid on certain home mortgages
6. Retirement savings contribution credit
7. Residential energy efficient property credit
Note that the popular alternative motor vehicle credit which applies to individuals who acquire hybrid cars is not permitted to be used to reduce a taxpayer's AMT. The credit is permitted to offset one's regular tax liability only.
After 2009, only the adoption credit, child tax credit and the retirement savings contribution credit may be used to offset both a taxpayer's regular tax and AMT. The other credits may offset regular tax only. However, Congress has routinely added the allowance of these nonrefundable personal credits as an offset to a taxpayer's AMT along with the increase in the AMT exemption. Many times these AMT changes have been passed late in the year for which they are effective.
A taxpayer that has business tax credits may not use the credits to offset their AMT in a given year. The general business credit of a taxpayer is limited to the taxpayer's net regular tax (net of nonrefundable personal credits, foreign tax credit, and certain other rarely used credits) plus AMT, less the larger of (1) tentative minimum tax or (2) 25% of the amount by which the net regular tax exceeds $25,000. (94)
Example: Jessica Nelson's net regular tax liability for 2009 was $50,000. Her tentative minimum tax was $47,000. She also received a $5,000 general business credit from one of her partnership investments. She is permitted to claim $3,000 of the credit against her 2009 tax liability and thereby reduce her regular tax to $47,000. The remaining $2,000 may be carried forward to future years subject to carryforward limitations.
MINIMUM TAX CREDIT
Taxpayers that are caught by the AMT may have the opportunity to recoup some of that payment in future years through the minimum tax credit (MTC). (95) For individuals, the MTC is created by AMT that is attributable to deferral adjustments or preferences. Deferral adjustments and preferences are ones that are merely a matter of timing. AMT that is attributable to exclusion adjustments and preferences does not create a MTC.
Exclusion adjustments and preferences include (96):
2. Medical expenses
3. Certain residential interest expense
4. Miscellaneous itemized deductions
5. Standard deduction
6. Personal exemptions
7. Excess depletion
8. Tax-exempt interest from private activity bonds
9. Applicable add back for the Section 1202 exclusion for gain from the sale of small business stock
All other AMT adjustments and preferences will add to the MTC.
For individuals, the MTC equals the difference between the taxpayer's actual AMT and the AMT that would have been owed if only the exclusion adjustments and preferences were considered in computing the AMT. (97) The MTC is available to reduce a taxpayer's regular tax liability to the extent regular tax exceeds the current year tentative minimum tax. Any unused MTC is carried forward to offset future regular tax liability. Individuals report the MTC on Form 8801.
Example: In 2007, Jerry Lappas exercised a number of ISOs and, as a result, paid $25,000 of AMT. The only other adjustment he had for AMT purposes was his standard deduction and personal exemption. When preparing his 2008 individual income tax return, Jerry must determine the amount of the MTC available to him. He does this by completing Form 8801 and recomputing his 2007 AMT without the exclusion adjustments for his standard deduction and personal exemption. Without these adjustments, his 2007 AMT would have been $22,000. This amount represents the amount of AMT that is attributable to deferral type AMT adjustments and preferences and becomes Jerry's MTC to be utilized against his regular liability to the extent it exceeds his tentative minimum tax in 2008 and future years until the MTC is fully utilized.
The MTC for corporations is determined without making any adjustments to the AMT paid in prior years unlike what is required for individuals. (98) If a corporation pays the AMT in a prior year, that amount is available as a MTC in subsequent years offset the entity's regular tax liability. Corporations use Form 8827 to determine the MTC.
Example: Palace Amusements paid $5,000 of AMT in 2007. In 2008, the company's regular tax liability, before the MTC, was $55,000. The company's tentative minimum tax was $47,000. Since the utilization of the MTC against regular tax does not reduce the tax below the company's tentative minimum tax, the full amount of the MTC is allowed in 2008. The company's net tax liability for 2008 is $50,000 ($55,000-$5,000).
Refundable Minimum Tax Credit
Beginning in 2007 and ending with the 2012 tax year, the Tax Relief and Healthcare Act of 2007 allowed taxpayers with long-term unused minimum tax credits an opportunity to benefit from the minimum tax credit sooner. This "Refundable Minimum Tax Credit" was equal to the greater of $5,000 or 20% of the long-term unused MTC for the year. The primary purpose of creating this provision was to give relief to the many taxpayers who exercised incentive stock options in prior years and, for one reason or another, have not benefited from the existing MTC rules.
A long-term unused MTC is defined as the MTC carried over from prior years that was generated more than three years before the the current tax year (e.g. 2003 for 2007). Minimum tax credits for the three years immediately preceding the current tax year are determined under the normal rules. MTCs are utilized on a first-in, first out basis.
In determining the refundable MTC for 2007, taxpayers were subject to a phase-out of the size of the allowable credit. 99 As a result, for many high-income taxpayers, the refundable MTC was not available to offset their tax liability in 2007.
The Emergency Economic Stabilization Act of 2008 changed the refundable MTC provision for taxpayers with long-term unused minimum tax credits. Beginning in 2008 and extending through 2013, the credit is increased to the greater of 50% of the unused long-term minim tax credit or the amount of the refundable minimum tax credit determined in the previous tax year. The adjusted gross income limitation, which was part of the law for 2007, was repealed. (100)
Example: John Crossed exercised incentive stock options in 2002 and generated an AMT liability of $90,000. It was determined that all of the AMT liability was eligible for the minimum tax credit. Due to the size of his income and the continued exposure to the AMT, none of the $90,000 minimum tax credit had been used through 2007. For 2008, John will be permitted to take a credit of $45,000 against his tax liability, regardless of his level of income or if he will be an AMT taxpayer in 2008. The balance of the $45,000 minimum tax credit will be recovered in 2009.
(1.) The Individual Alternative Minimum Tax: Historical Data and Projections, Updated June 2008 22 November 2008; www.taxpolicycenter.org.
(2.) IRC Sec. 55(b)(1)(A).
(3.) IRC Sec. 55(b)(3).
(4.) IRC Sec. 55(b)(2).
(5.) IRC Sec. 55(b)(2)(A).
(6.) IRC Sec. 55(b)(2)(B).
(7.) IRC Sec. 55(d)(1).
(8.) IRC Sec. 55(d)(3).
(9.) IRC Sec. 55(d)(3).
(10.) IRC Sec. 55(b)(2).
(11.) IRC Sec. 55(b)(2)(A).
(12.) IRC Sec. 55(b)(2)(B).
(13.) IRC Sec. 56(g)(1).
(14.) IRC Sec. 56(g)(2).
(15.) IRC Sec. 56(g)(2)(B).
(16.) IRC Sec. 55(b)(1)(B).
(17.) IRC Sec. 55(d)(2).
(18.) IRC Sec. 1561(a)(3) for groups defined under IRC Sec. 1563(a).
(19.) IRC Sec. 1561(a).
(20.) IRC Sec. 56(a)(1).
(21.) 1987-2 C.B. 674.
(22.) IRC Sec. 56(a)(1)(A).
(23.) IRC Sec. 168(k)(2)(G).
(24.) Rev. Proc. 2002-33, 2002-1 CB 963.
(25.) IRC Sec. 56(a)(2).
(26.) IRC Sec. 56(a)(3).
(27.) IRC Sec. 56(a)(4).
(28.) IRC Sec. 56(d)(2).
(29.) IRC Sec. 56(d)(1)(A).
(30.) IRC Sec. 56(a)(6).
(31.) IRC Sec. 56(b)(1)(A)(i).
(32.) IRC Sec. 56(b)(1)(A)(ii).
(33.) IRC Sec. 213(a).
(34.) IRC Sec. 56(b)(1)(B).
(35.) IRC Sec. 56(b)(1)(C).
(36.) IRC Sec. 56(e)(1)(A).
(37.) IRC Sec. 56(e)(1)(B).
(38.) IRC Sec. 56(b)(1)(D).
(39.) IRC Sec. 56(b)(1)(E).
(40.) IRC Sec. 421(a).
(41.) IRC Sec. 422(a)(1).
(42.) IRC Sec. 56(b)(3).
(43.) IRC Sec. 58(b).
(44.) IRC Sec. 56(c)(1).
(45.) IRC Sec. 170(b)(1).
(46.) TAM 9320003.
(47.) IRC Sec. 57(a)(1).
(48.) IRC Sec. 57(a)(2)(A).
(49.) IRC Secs. 57(a)(2)(B) and 57(b)(1).
(50.) IRC Sec. 57(a)(5)(A).
(51.) IRC Sec. 57(a)(5)(C)(i).
(52.) IRC Sec. 57(a)(5)(B).
(53.) IRC Sec. 57(a)(6).
(54.) IRC Sec. 1202(a)(1).
(55.) IRC Sec. 1202(c)(1).
(56.) IRC Sec. 1202(c)(1)(B).
(57.) IRC Sec. 1202(c)(2).
(58.) IRC Sec. 1202(c)(1)(A).
(59.) IRC Sec. 1202(d).
(60.) IRC Sec. 57(a)(7).
(61.) IRC Sec. 55(e)(1)(A).
(63.) IRC Sec. 55(e)(1)(C).
(64.) IRC Sec. 55(e)(1)(B).
(65.) IRC Sec. 55(e)(1)(D).
(66.) IRC Sec. 55(e)(4).
(67.) IRC Sec. 55(e)(2)(A).
(68.) IRC Sec. 55(e)(2)(B).
(69.) IRC Sec. 55(e)(2)(C).
(70.) IRC Sec. 55(e)(2)(D).
(71.) IRC Sec. 55(e)(2)(E).
(72.) IRC Sec. 55(e)(2)(F).
(73.) IRC Sec. 55(e)(2)(G).
(74.) IRC Sec. 56(g)(3).
(75.) IRC Sec. 56(g)(4)(A)(ii).
(76.) IRC Sec. 56(g)(4)(A)(iii).
(77.) IRC Sec. 56(g)(4)(A)(iv).
(78.) IRC Sec. 56(g)(4)(A)(i).
(80.) IRC Sec. 56(g)(4)(B)(i)(I).
(81.) IRC Sec. 56(g)(4)(B)(i)(II).
(82.) IRC Sec. 56(g)(4)(C)(ii).
(83.) IRC Sec. 56(g)(4)(D)(i).
(84.) IRC Sec. 56(g)(4)(D)(ii).
(85.) IRC Sec. 56(g)(4)(D)(iii).
(86.) IRC Sec. 56(g)(4)(D)(iv).
(87.) IRC Sec. 56(g)(4)(B)(i).
(88.) IRC Sec. 56(g)(4)(I).
(89.) IRC Sec. 56(g)(1).
(90.) IRC Sec. 56(g)(2).
(91.) IRC Sec. 56(g)(2)(B).
(92.) IRC Sec. 59(a)(1).
(93.) IRC Sec. 26(a)(2).
(94.) IRC Sec. 38(c).
(95.) IRC Sec. 53(a).
(96.) IRC Sec. 53(d)(1)(B)(ii).
(97.) IRC Sec. 53(d)(1)(B)(i).
(98.) IRC Sec. 53(d)(1)(B)(iv).
(99.) For 2007 the phase-out was determined by reducing the refundable MTC by 2% for each $2,500 ($1,250 for separate filers), or fraction thereof, by which a taxpayer's AGI exceeded $234,600 for joint filers, $156,400 for single filers, $195,500 for head of household filers and $117,399 for married taxpayers filing separately.
(100.) The Emergency Economic Stabilization Act of 2008 also abated the tax liabilities for any taxpayers who had an existing underpayment of tax outstanding as of the date of enactment attributable the exercise of incentive stock options in a tax year ending before January 1, 2008. To the extent a liability was discharged under this provision, the amount would not be eligible for a future MTC.
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|Publication:||Tools & Techniques of Income Tax Planning, 3rd ed.|
|Date:||Jan 1, 2009|
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