Working With the Alternative Minimum Tax

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Working With the Alternative Minimum Tax
Craig White, CPA, PhD. Associate
Professor Accounting Department Anderson Schools
of Management University of New Mexico
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Overview

• The tax laws give preferential treatment to
  certain kinds of income and allow special
  deductions and credits for certain kinds of
  expenses. The alternative minimum tax (AMT)
  attempts to ensure that all individuals as well
  as, estates, trusts and C corporations with a
  certain level of gross receipts who benefit from
  these tax advantages will pay at least a minimum
  amount of tax.
•  
• The AMT is a separate tax computation that
  eliminates many deductions and credits, and
  changes the timing of the recognition of certain
  income and expense items relative to the regular
  tax computation.
•  
• In general, the AMT increases the tax base
  relative to the regular tax. If this broader tax
  base, in conjunction with the AMT tax rates,
  produces a larger tax than the regular tax
  computation, the taxpayer pays the difference as
  an alternative minimum tax.

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Timing Implications of the AMT
 Individuals, estates, trusts The AMT can have
both timing and permanent difference effects
relative to the regular tax. A Minimum Tax
Credit (MTC) is allowed for AMT generated from
timing difference items (for example,
depreciation timing differences relative to
regular tax). The credit is not allowed for AMT
generated from permanent difference items (for
example, itemized deduction add backs). The MTC
can be used in a year where the regular tax (net
of certain credits) exceeds the Tentative Minimum
Tax. The MTC can be used up to the excess of the
regular tax (net of certain credits) over the
Tentative Minimum Tax. Any excess carries over
to future years. C Corporations subject to the
AMT The AMT is a timing difference relative to
the regular tax. All modifications to the tax
base for AMT purposes are treated as timing
difference items. Thus, any AMT paid by a
corporation results in a MTC that can be carried
forward for use in later years.
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Individual Alternative Minimum Tax

• IRC sections 55,56,57,58,59
• The calculation is performed on Form 6251. The
  MTC is calculated on Form 8801.
• Alternative minimum taxable income is determined
  by modifications to regular taxable income.

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Individual Alternative Minimum Tax Formula
Regular Taxable Income Plus or minus
Adjustments Plus Tax Preferences Plus Regular
Tax NOL Minus Any Regular Tax Itemized
Deduction Cutback Minus AMT NOL (limited to 90
percent of AMTI) Equals Alternative Minimum
Taxable Income Minus Exemption Equals
Alternative Minimum Tax Base AMT tax rates of 26
and 28 percent (Capital Gains and Dividends are
taxed at favorable rates as they are for
Regular tax). Equals Tentative Minimum Tax
Before Foreign Tax Credit Minus Alternative
Minimum Tax Foreign Tax Credit (limited to 90
percent of TMT) Equals Tentative Minimum
Tax Minus Regular Tax Liability (reduced by any
allowable foreign tax credit) Equals Alternative
Minimum Tax (if amount is positive)
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Adjustments (See Form 6251 for Complete Listing)
Certain Itemized Deductions Medical
Expenses Increases threshold for deduction from
7.5 percent of AGI for Regular Tax up to 10
percent for AMT. Taxes Add back state income
tax, property tax on realty, property tax on
personalty, and other taxes deducted (ex. Foreign
taxes elected to be deducted). Interest Home
Equity Interest not used to buy, build or improve
home Difference between AMT and Regular Tax
investment interest expense ( Can arise from
investments financed with a home equity loan or
with differences in capital gains on
dispositions) Miscellaneous Itemized Deductions
Added back Tax Benefit Rule for State Tax Refunds
Any state tax refund that is added into Regular
taxable income due to the tax benefit rule is
subtracted out for AMT (never received an AMT
benefit). Reduction of Itemized Deductions
Subtracted out for AMT purposes. Standard
Deduction Added to Regular Taxable Income (If
not itemizing)
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Adjustments (See Form 6251 for Complete Listing)
Personal and Dependency Exemptions Added back
for AMT purposes.   Other Common Adjustment
Items Depreciation of Post1986 Real Property
positive or negative - The difference between
Regular and AMT Depreciation amounts. Generally,
post-1986 real property has been depreciated over
40 years for AMT and either 27.5 (residential
rental property) or 39 years (nonresidential real
property (31.5 years for pre-May 13, 1993)) for
Regular tax purposes. For real property placed
in service after December 31, 1998, the AMT
recovery period conforms to Regular
tax. Depreciation of Post-1986 Personal Property
- positive or negative The difference between
Regular and AMT Depreciation amounts. The
adjustment is due to differences between the
recovery period and method of depreciation
(generally, 200 DDB v. 150 DDB). For
property placed in service after December 31,
1998, Regular tax recovery periods are applicable
for AMT. Thus, if the taxpayer elects 150 DDB
for Regular tax there will be no AMT adjustment
on this property. Adjusted Gain or Loss
positive or negative Disposition of property
that has a different adjusted basis for Regular
tax as opposed to AMT.
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Adjustments (See Form 6251 for Complete Listing)
The additional first year depreciation deduction
is allowed for both regular tax and alternative
minimum tax purposes. However, for alternative
minimum tax purposes, the amount of the
additional first year depreciation deduction is
based on the unadjusted depreciable basis of the
property for alternative minimum tax purposes.
The amount of the additional first year
depreciation deduction is not affected by a
taxable year of less than 12 months for either
regular or alternative minimum tax purposes.
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Adjustments (See Form 6251 for Complete Listing)
Incentive Stock Options positive or negative
The exercise of an ISO does not increase regular
taxable income. For AMT purposes, the exercise
of an ISO results in an adjustment for the excess
of the fair market value of the stock over the
exercise price in the first year the stock is
freely transferable or not subject to a
substantial risk of forfeiture. The recognition
of this income for AMT purposes increases the AMT
basis in the stock. Thus, when the stock is sold
there will be a negative adjustment relative to
Regular tax. No adjustment is necessary if the
exercise of the option and the disposition of the
stock occur in the same tax year (Section
56(b)(3)). Possibility of a Section 83(b)
election for AMT purposes.   Passive Activities
Difference between Regular tax and AMT passive
income or loss. This difference is generated by
adjustment or preference items coming from
passive activities (ex. Depreciation
differences).  
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Preferences (See Form 6251 for Complete Listing)
  Section 1202 Exclusion For 2003 dispositions
before May 6, 2003, 28 percent of the excluded
gain amount is added back. After this point, the
add back amount is 7 percent of the excluded
gain   Tax Exempt Interest From Private Activity
Bonds Government bonds used to subsidize
private activities Add back interest less
deductions associated with generating the
interest income.
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AMT Exemption Amount
The exemption is 22,500 for estates and
trusts. The exemption phases out at the rate of
.25 for each dollar AMTI exceeds certain
threshold amounts MFJ 150,000 MFS 75,000 Sin
gle, Head of Household 112,500
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AMT Tax Rates

• Basic Rates (Half of the base amount for MFS)
• 26 up to a Alternative minimum tax base of
  175,000
• 28 on amounts over 175,000
• Capital Gain and Dividend Rates apply for AMT

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The Jobs and Growth Tax Relief Reconciliation Act
of 2003 Brings a Complicated Mix of Rules For the
Foreseeable Future
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The Jobs and Growth Tax Relief Reconciliation Act
of 2003 Brings a Complicated Mix of Rules For the
Foreseeable Future
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Projected Tax Schedule for Married Filing Jointly
for 2003
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The Alternative Minimum Tax Congress and the
Administration have made clear that they support
further efforts to provide relief from the
individual Alternative Minimum Tax. Such relief
was enacted in the 2001 tax legislation and made
more generous in the 2003 tax cut, but expires
after 2004. Virtually all observers consider the
continuation of AMT relief inevitable. Without
such relief, the number of taxpayers subject to
the AMT would explode from about 2 1/2 million
today to 33 million in 2010 and almost 42 million
by 2013, if the 2001 tax cut is extended past its
2010 expiration date.11 The Administration
has said it plans to address the AMT issue in
2005. Some policymakers call for the complete
repeal of the AMT. CBO's August report shows that
indexing the parameters of the AMT for inflation
would cost about 580 billion through 2013, or
about 690 billion counting interest, and we use
that figure in our analysis./4/ Even under this
policy, the number of tax filers subject to the
AMT would rise from its current level of less
than 3 million to more than 6 million, or 4
percent of all tax filers, by 2013.
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Section 26(a)(1) provides the general rule that
nonrefundable personal credits cannot exceed the
excess of regular tax liability over the
tentative minimum tax.

• Total of - the child and dependent care credit
  (Code Sec. 21), the credit for the elderly and
  disabled (Code Sec. 22), the credit for adoption
  expenses (Code Sec. 23), the nonrefundable
  portion of the child tax credit (Code Sec. 24),
  the credit for interest paid on mortgage credit
  certificates (Code Sec. 25), the education
  credits (Code Sec. 25A)), the savers' credit
  (Code Sec. 25B), and the District of Columbia
  homebuyer's credit (Code Sec. 1400C
• However, for any tax year beginning during 1998
  and 1999, an individual's tentative minimum tax
  was to be treated as zero for purposes of
  determining the allowable amount of nonrefundable
  personal credits (Code Sec. 26(a)(1)).

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Section 26(a)(1) provides the general rule that
nonrefundable personal credits cannot exceed the
excess of regular tax liability over the
tentative minimum tax.

• A special rule for tax years beginning in 2000
  and 2001 was added by the 1999 Act (P.L. 106-170)
  and it was extended to tax years beginning in
  2002 and 2003 by the Job Creation and Worker
  Assistance Act of 2002 (P.L. 107-147) (Code Sec.
  26(a)(2)). The personal nonrefundable credits may
  offset both the regular tax liability and the
  minimum tax for tax years beginning in 2000,
  2001, 2002, and 2003. Before applying this
  special rule, however, the regular tax liability
  must be reduced by any foreign tax credit (Code
  Sec. 26(a)(2)).
• The general tax limitation rule will become
  effective again in 2004 except that it will not
  apply to certain nonrefundable personal credits.
  The Economic Growth and Tax Relief Reconciliation
  Act of 2001 (P.L. 107-16) provided separate tax
  liability limitation rules for the adoption
  credit (Code Sec. 23), the child credit (Code
  Sec. 24), and the savers' credit (Code Sec. 25B).
  This change made by P.L. 107-16 does not apply to
  tax years beginning after December 31, 2010.

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Calculation of the Minimum Tax Credit (Form 8801
for Individuals, Estates, and Trusts)

• The credit is for AMT generated from timing
  differences and not permanent differences. Form
  8801 refers to timing difference items as
  deferral items and permanent difference items
  as exclusions.
•   Part I of Form 8801 calculates the AMT, for the
  previous tax year, attributable to exclusion
  items.
•   Part II of Form 8801 begins with the total AMT
  for the prior tax year and subtracts out the
  amount from Part I. The result plus any prior
  MTC carry forward amount is the amount available
  for credit in the current tax year.
•  The MTC is allowed up to the excess of (Regular
  tax - all nonrefundable credits) over the current
  year tentative minimum tax.

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C Corporations (Forms 4626 and 8827)
Exemption for Small Corporations A small
corporation is defined in terms of its average
gross receipts. A corporation initially qualifies
as a small corporation if it had average gross
receipts of 5 million or less in the preceding
three-year period. If the corporation has not
been in existence for the entire three-year
period, the test is based on the period the
corporation has been in existence. Once a
corporation passes the 5 million mark, it is
still treated as a small corporation as long as
its average gross receipts for the preceding
three-year period do not exceed 7.5 million.
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C Corporations (Forms 4626 and 8827)
Exemption for Small Corporations This test is
subject to the controlled group rules. If the
corporation exceeds the average gross receipts
test, the AMT is applied on a prospective basis.
For instance, any depreciation adjustments only
apply for property placed in service in tax years
in which the corporation became subject to the
AMT. Gross Receipts Total sales (net of returns
and allowances) and all amounts received for
services, plus any income from investments and
from other incidental and outside sources. Gross
receipts are reduced by the adjusted bases of any
capital assets or section 1231 assets sold. Once
the threshold is passed, the AMT is applied on a
prospective basis (e.g., AMT adjustments only
apply to assets purchased after passing the
threshold).
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The IRS Asked That Practitioners Exam the
Necessity of Corporate AMT Calculations
Some small corporations have been reporting and
paying alternative minimum tax (AMT) for which
they are not liable. AMT was repealed for
qualifying small corporations for tax years
beginning after December 31, 1997, but some of
these businesses continue to compute and pay AMT
on Form 1120, U.S. Corporation Income Tax Return.
The IRS is committed to alleviating this
unnecessary burden on small businesses through
education about the AMT exemption rules. As part
of IRS education efforts, letters were mailed out
on May 30, 2003, to small corporations who have
filed returns reporting and paying AMT, but may
be exempt.
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Corporate Alternative Minimum Tax Formula
Regular Taxable Income Plus or minus
Adjustments Plus Tax Preferences Plus Regular
Tax NOL Plus or minus ACE adjustment Minus
AMT NOL (limited to 90 percent of AMTI before
NOL) Equals Alternative Minimum Taxable
Income Minus Exemption Equals Alternative
Minimum Tax Base AMT tax rate at a flat 20
percent. Equals Tentative Minimum Tax Before
Foreign Tax Credit Minus Alternative Minimum Tax
Foreign Tax Credit (limited to 90 percent of
TMT) Equals Tentative Minimum Tax Minus
Regular Tax Liability (reduced by any allowable
foreign tax credit) Equals Alternative Minimum
Tax (if amount is positive)
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Corporate Adjustments and Preferences
Adjustment Examples Depreciation of Post1986
Real Property positive or negative - The
difference between Regular and AMT Depreciation
amounts. Generally, post-1986 real property has
been depreciated over 40 years for AMT and either
27.5 (residential rental property) or 39 years
(nonresidential real property (31.5 years for
pre-May 13, 1993)) for Regular tax purposes. For
real property placed in service after December
31, 1998, the AMT recovery period conforms to
Regular tax. Depreciation of Post-1986 Personal
Property - positive or negative The difference
between Regular and AMT Depreciation amounts.
The adjustment is due to differences between the
recovery period and method of depreciation
(generally, 200 DDB v. 150 DDB). For
property placed in service after December 31,
1998, Regular tax recovery periods are applicable
for AMT. Thus, if the taxpayer elects 150 DDB
for Regular tax there will be no AMT adjustment
on this property. Adjusted Gain or Loss
positive or negative Disposition of property
that has a different adjusted basis for Regular
tax as opposed to AMT. Preference
Example Percentage Depletion in excess of the
adjusted basis of the property.
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Adjusted Current Earnings (ACE) Adjustment

• ACE adjustment is 75 of the difference between
  adjusted current earnings and pre-ACE AMTI.
• Negative ACE adjustment is only allowed to the
  extent of prior positive ACE adjustments

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Adjusted Current Earnings (ACE) Adjustment

• Various Items Added Back to AMTI for ACE
  Calculation
• Tax-exempt income (net of expenses)
• Dividends Received Deduction (70 Category)
• Key employee insurance proceeds
• Intangible Drilling Costs Deducted Currently
• Deferred Gain on Installment Sales
• Net buildup on life insurance policy
• No Depreciation adjustment for property placed in
  service after 1993. Property placed in service
  prior to 1994, straight-line under ADS method.

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AMT Net Operating Loss

• The AMT net operating loss is normally limited
  to 90 percent of AMTI computed without regard to
  the AMTNOL
• AMT NOLs generated in 2001 and 2002 are allowed
  a five year carryback and can offset up to 100
  percent of AMTI.
• Likewise, AMT NOLs carried forward to 2001 and
  2002 can offset up to 100 percent of AMTI.

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Corporate AMT Exemption and Tax Rate
- Exemption 40,000 on a controlled group basis -
Exemption phases-out .25 for each dollar AMTI
exceeds 150,000 - Corporations are subject to a
flat 20 percent AMT rate
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Calculation of the Corporate Minimum Tax Credit
(Form 8827)

• All adjustment and preference items are treated
  as timing differences.
• - Thus, the entire alternative minimum tax
  becomes a minimum tax credit amount for use in
  future years.
• The MTC may be used up to the excess of Regular
  tax over the tentative minimum tax liability.
• A small corporation's allowable Minimum tax
  credit is limited to the amount by which the
  corporation's regular tax liability (reduced by
  other credits) exceeds 25 percent of the excess
  (if any) of the corporation's regular tax
  (reduced by other credits) over 25,000 (Code
  Sec. 55(e)(5)).