© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Individual Income Taxes 1 Chapter 12 Alternative Minimum Tax

2 The Big Picture (slide 1 of 2) Bob and Carol are unmarried individuals who have been engaged for four months. They work for the same employer and –They earn identical compensation. –They have the same amount of gross income, including the same amount of investment income, which consists solely of interest income. –They have similar investments in tax-exempt bonds that produce identical amounts of interest income. –They also have the same amount of deductions. Carol learns that she paid $15,000 more in Federal income taxes than Bob did for the tax year.

3 The Big Picture (slide 2 of 2) The above events raise a number of interesting questions for Bob and Carol that can be answered after completing this chapter. –Why didn’t Bob and Carol have the same tax liability? –Were both tax returns properly prepared? –Should Carol consider replacing her tax return preparer Ava with Adam? –Is it possible and/or desirable for Carol to file an amended return? –Should Bob do anything? Read the chapter and formulate your response.

4 Alternative Minimum Tax (AMT) AMT is separate from, but parallel to, the regular income tax system The AMT computation reconciles taxable income, through adjustments and preferences, with Alternative Minimum Taxable Income (AMTI)

5 Computation of AMT

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8 AMT Adjustments And Preferences (slide 1 of 3) Most AMT adjustments relate to timing differences –Timing differences eventually reverse Positive adjustments will be offset by negative adjustments in the future, and vice versa –Example - circulation expenditures For regular income tax purposes, circulation expenditures can be deducted in the year incurred For AMT purposes, however, circulation expenditures must be deducted over a three-year period Certain AMT adjustments do not relate to timing differences –These adjustments result in a permanent difference between taxable income and AMTI e.g., Itemized deductions

9 AMT Adjustments And Preferences (slide 2 of 3) AMT Preferences –Designed to take back all or part of the tax benefits obtained by certain items in the computation of taxable income for regular income tax purposes Taxable income is increased by tax preference items effectively disallowing those tax benefits for AMT purposes

10 AMT Adjustments And Preferences (slide 3 of 3) Tax preferences include: –Percentage depletion in excess of basis –Excess intangible drilling costs –Interest on certain private activity bonds –Excess of accelerated over straight-line depreciation on real & leased personal property placed in service before 1987 –Excess of amortization allowance over depreciation on pre certified pollution control facilities –7% of the exclusion from gross income of gains on the sale of certain small business stock

11 Other Components of AMT (slide 1 of 3) Exemption amount –The exemption reduces AMTI to arrive at the base on which AMT is computed –The exemption is phased out at a rate of 25 cents on the dollar when AMTI exceeds the above amounts

12 Other Components of AMT (slide 2 of 3) For 2015, the exemption and phaseout amounts are as follows:

13 Other Components of AMT (slide 3 of 3) AMT rates –A progressive rate structure is applied to the tax base (AMTI less exemption amount) 26% on first $185,400 ($92,700 for married, filing separately) of tax base in % on remaining amount of tax base –Net capital gain and qualified dividend income included in AMT base are taxed at favorable alternative tax rates (0%, 15%, or 20%)

14 Personal Tax Credits Beginning in 2012, personal nonrefundable credits are allowed to offset any AMT liability as well as any regular tax liability –e.g., Adoption Credit, Lifetime Learning Credit, and Retirement Savings Contribution Credit

15 AMT Adjustments (slide 1 of 15) Adjustments tend to arise from timing differences between regular tax and AMT –Adjustments can be positive or negative, and will generally reverse in later years

16 Adjustments (slide 2 of 15) The AMT depreciation adjustment for real property applies only to real property placed in service before January 1, 1999 For real property placed in service after December 31, 1998, MACRS recovery periods apply for AMT –Thus, the AMT adjustment is effectively eliminated

17 Adjustments (slide 2 of 15) The AMT depreciation adjustment for real property applies only to real property placed in service before January 1, 1999 For real property placed in service after December 31, 1998, MACRS recovery periods apply for AMT –Thus, the AMT adjustment is effectively eliminated

18 Adjustments (slide 3 of 15) For real property placed in service after 1986 (MACRS property) and before January 1, 1999 –AMT depreciation is computed under the alternative depreciation system (ADS) Uses the straight-line method over a 40-year life –Regular tax MACRS lives are 27.5, 31.5, and 39 years

19 Adjustments (slide 4 of 15) Depreciation of post-1986 personal property –AMT method is 150% DB over ADS life –Regular tax is generally MACRS method based on 200% DB over shorter lives Effective for personalty placed in service after 12/31/98, MACRS recovery periods are to be used for AMT –If 150% DB is elected for this property, there is no AMT adjustment For property for which additional first-year depreciation deduction (bonus depreciation) is elected, no depreciation adjustment for AMT purposes is required.

20 Adjustments (slide 4 of 15) Depreciation of post-1986 personal property –AMT method is 150% DB over ADS life –Regular tax is generally MACRS method based on 200% DB over shorter lives Effective for personalty placed in service after 12/31/98, MACRS recovery periods are to be used for AMT –If 150% DB is elected for this property, there is no AMT adjustment For property for which additional first-year depreciation deduction (bonus depreciation) is elected, no depreciation adjustment for AMT purposes is required.

21 Adjustments (slide 5 of 15) Pollution control facilities –Depreciate under the ADS over appropriate class life for AMT Amortize over 60 months for regular tax purposes –Effective for pollution control facilities placed in service after 12/31/98, MACRS recovery periods are to be used for AMT

22 Adjustments (slide 6 of 15) Circulation expenditures –Amortized over 3 years for AMT Expensed in year incurred for regular tax

23 Adjustments (slide 6 of 15) Circulation expenditures –Amortized over 3 years for AMT Expensed in year incurred for regular tax

24 Adjustments (slide 7 of 15) Mining exploration/development costs and research/experimental expenditures –Amortized over 10 years for AMT Expensed in year incurred for regular tax purposes –Taxpayer may elect to capitalize and amortize over 10 years for regular tax purposes and thus avoid the AMT adjustment

25 Adjustments (slide 8 of 15) Completed contract method –AMT requires the use of percentage of completion method for long-term contracts rather than completed contract method

26 Adjustments (slide 9 of 15) Incentive stock options (ISOs) –The exercise of an ISO can cause income for AMT purposes that is not currently taxable for regular tax purposes Excess of FMV over exercise price is adjustment in the taxable year in which the option is exercised

27 Adjustments (slide 9 of 15) Incentive stock options (ISOs) –The exercise of an ISO can cause income for AMT purposes that is not currently taxable for regular tax purposes Excess of FMV over exercise price is adjustment in the taxable year in which the option is exercised

28 Adjustments (slide 10 of 15) Adjusted gain or loss –Since the adjusted basis of an asset can be different for regular tax and AMT, gain or loss recognized upon the disposition of an asset may vary for the two tax systems –Difference between regular tax gain (loss) and AMT gain (loss) is adjustment

29 Adjustments (slide 11 of 15) Passive activity losses - Not deductible in computing either the regular income tax or the AMT –Passive losses must still be recomputed for AMT using AMT provisions

30 Adjustments (slide 12 of 15) Net operating loss (NOL) –NOL must be recomputed for AMT using AMT provisions –The starting point in computing the alternative tax NOL deduction (ATNOLD) is the NOL computed for regular income tax purposes. The regular income tax NOL is then modified for AMT adjustments and tax preferences with the result being the ATNOLD

31 Adjustments (slide 13 of 15) Itemized deductions allowed for AMT purposes include: Casualty losses Gambling losses Charitable contributions Medical expenses in excess of 10% of AGI Estate tax attributable to IRD Qualified interest –May differ from regular tax since only student loan, qualified residence, and investment interest are deductible for AMT

32 Adjustments (slide 13 of 15) Itemized deductions allowed for AMT purposes include: Casualty losses Gambling losses Charitable contributions Medical expenses in excess of 10% of AGI Estate tax attributable to IRD Qualified interest –May differ from regular tax since only student loan, qualified residence, and investment interest are deductible for AMT

33 Adjustments (slide 14 of 15) Itemized deductions not allowed for AMT: –Taxes and miscellaneous itemized deductions subject to the 2% AGI limit Gross income may include a refund of taxes deducted in prior years as an itemized deduction –A negative AMT adjustment is allowed for such refunds for AMT purposes The 3% cutback of regular income tax itemized deductions does not apply for AMT

34 Adjustments (slide 15 of 15) Other adjustments –AMT does not allow the standard deduction and personal and dependency exemptions These adjustments enter the AMTI calculation indirectly by adjusting the taxable income amount that begins the AMTI calculation

35 Preferences (slide 1 of 5) Preferences tend to arise because of deductions or exclusions that provide substantial tax benefits –Unlike adjustments, preferences can only be positive (i.e., increase AMTI) –Thus, preferences reduce the benefits initially received when computing regular tax

36 Preferences (slide 2 of 5) Percentage depletion –Preference is the amount of percentage depletion taken for regular tax which is in excess of the adjusted basis of the property at the end of the year

37 Preferences (slide 3 of 5) Intangible drilling costs –Deductible currently for regular tax –The AMT preference is computed as follows: IDC expensed in the year incurred Minus: Deduction if IDC were capitalized and amortized over 10 years Equals: Excess of IDC expense over amortization Minus: 65% of net oil and gas and geothermal income Equals: Tax preference item

38 Preferences (slide 4 of 5) Interest on private activity bonds –This interest is not taxable for regular tax purposes but is included in income for AMT purposes –Expenses incurred in carrying these bonds are not deductible for regular tax purposes, but offset the interest income in computing the AMT preference –Interest on private activity bonds issued after December 31, 2008 and before January 1, 2011 is not treated as a tax preference

39 Preferences (slide 5 of 5) 50% exclusion of gain on sale of certain small business stock normally is excludible from gross income for regular tax –For 2009 and 2010, the 50% is increased to 75% –For such stock acquired after September 2, 2010, and before January 1, 2015, 100% of the gain is excluded from regular taxable income –7% of the excluded amount is a tax preference for AMT

40 The Big Picture - Example 21 Private Activity Bonds Return to the facts of The Big Picture on p Bob and Carol both have invested substantial amounts in private activity bonds all of which were issued in –A tax preference does not result for either Carol or Bob.

41 AMT Credit AMT attributable to timing differences is AMT Credit –Excess of AMT over AMT computed without timing differences AMT credit can be carried forward (indefinitely) to be used to offset regular income tax liability –Cannot carryback or use against AMT liability

42 Corporate AMT (slide 1 of 4) Major differences in AMT rules for corporations –AMT rate is a flat 20% –Exemption amount is $40,000 Reduced by 25% of amount by which AMTI exceeds $150,000

43 Corporate AMT (slide 2 of 4) Major differences in AMT rules for corporations (cont’d) –Adjusted current earnings (ACE) adjustment Adjustment = 75% × (ACE - AMTI before ACE) ACE employs some earnings and profits concepts but certain differences exist Adjustment can be positive or negative –The negative adjustment is limited to the aggregate positive adjustments under ACE for prior years

44 Corporate AMT (slide 3 of 4) AMT is repealed for small corporations for tax years beginning after 12/31/97 –A corporation is classified as a small corporation if both of the following apply It was treated as a small corporation exempt from the AMT for all prior years beginning after 1997 Average gross receipts for the 3 year period ending before its current tax year did not exceed $7.5 million –$5 million if the corporation had only one prior tax year –However, if a corporation ever fails the gross receipts test, it is ineligible for small corporation classification in future tax years

45 Corporate AMT (slide 4 of 4) A new corporation is automatically classified as a small corporation its first tax year of existence

46 Minimum Tax Credit All of a corporation’s AMT is available for carryover as a minimum tax credit –Does not matter whether the adjustments and preferences originate from timing differences or AMT exclusions

47 Refocus On The Big Picture Bob contacts Adam, his tax return preparer, and explains in an excited voice that he believes that he underpaid his Federal income tax liability for 2014 by $15,000. –He is worried about the negative effects of an IRS audit. Adam examines the two tax returns and discovers that the difference relates to the treatment of the interest earned on the tax-exempt bonds. –Both Bob and Carol own tax-exempt bonds, including private activity bonds that usually are subject to the AMT. –However, Carol’s accountant, Ava, apparently overlooked the fact that interest on private activity bonds is not a tax preference for private activity bonds issued in So the $15,000 AMT that was reported on Carol’s Form 6251 is in error. –Bob ‘‘texts’’ the good news to Carol that she is eligible for a Federal income tax refund.

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 48 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA SUNY Oneonta