RETIREMENT TIPS: How to Avoid Alternative Minimum Tax

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AlanKondo-238x300By ALAN KONDO, CFP, CLU

The Alternative Minimum Tax (AMT) was originally created as a fallback tax for wealthy taxpayers who avoided regular taxes by claiming many exemptions and deductibles. Now, however, more individuals are finding themselves subject to the AMT. The mechanics of the AMT are complex. But a general understanding of how the tax works can help you avoid it and even use it to your advantage.

What Triggers the AMT?

The AMT truly functions as an “alternative” tax system. It has its own set of rates and rules for deductions, which are more restrictive than the regular rules. It operates in parallel with the regular income tax system in that if you are already paying at least as much under the “regular” income tax as you would under AMT, you do not have to pay AMT. But if your regular tax falls below this minimum, you have to make up the difference by paying the Alternative Minimum Tax.

The AMT can be triggered by a number of different variables. Certain circumstances and tax items are likely to trigger the AMT, including the following:

● Your gross income is $100,000 or higher.

● You have large numbers of personal exemptions.

● You have significant itemized deductions for state and local taxes, home equity loan interest, deductible medical expenses, or other miscellaneous deductions.

● You exercised incentive stock options (ISOs) during the year.

● You had a large capital gain.

● You own a business, rental properties, partnership interests, or S corporation stock.

To find out if you are subject to the AMT, fill out the worksheets provided with the instructions to Form 1040 or complete Form 6251, Alternative Minimum Tax — Individuals.

AMT rates start at 26%, rising to 28% at higher income levels. This compares with regular federal tax rates, which start at 10% and step up to 39.6%. Although the AMT rates may appear to cap out at a lower rate than regular taxes, the AMT calculation allows significantly fewer deductions, making for a potentially bigger bottom-line tax bite.

Unlike regular taxes, you cannot claim exemptions for yourself or other dependents, nor may you claim the standard deduction. You also cannot deduct state and local tax, property tax, and a number of other itemized deductions, including your home-equity loan interest, if the loan proceeds are not used for home improvements. Accordingly, the more exemptions and deductions you normally claim, the more likely it is that you will have an AMT liability.

Avoiding the AMT

Because large one-time gains and big deductions that trigger the AMT are sometimes controllable, you may be able to avoid or minimize the impact of the AMT by planning ahead. Here are some practical suggestions.

Time your capital gains. You may be able to delay an asset sale until after the end of the year, or spread a gain over a number of years by using an installment sale. If you are looking to liquidate an investment with a long-term gain, you should review your AMT consequences and determine what impact such a sale might have.

Time your deductible expenses. When possible, time payments of state and local taxes, home-equity loan interest (if the loan proceeds are not used for home improvements), and other miscellaneous itemized deductions to fall in years when you would not face the AMT. Since they are not AMT-deductible, they will go unused in a year when you pay the AMT. The same holds true for medical deductions, which face stricter deduction rules for the AMT.

Look before you exercise stock options. Exercising Incentive Stock Options (ISOs) is a red flag for triggering the AMT. The AMT on ISO proceeds can be significant. Because ISO tax issues are complex, you should consult with your tax professional before exercising ISOs.

This article is not intended to be tax advice and should not be treated as such. Each individual’s tax situation is different. You should contact your CPA to discuss your personal situation.

The opinions expressed above are solely those of Kondo Wealth Advisors, LLC, (626-449-7783 [email protected]), a Registered Investment Advisor in the state of California. Neither Kondo Wealth Advisors, LLC nor its representatives provide legal, tax or accounting advice.

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