Approximately four million taxpayers are expected to owe alternative minimum tax (AMT), despite congressional action to adjust the exemption level.
Introduced in 1969, the AMT is intended to ensure that wealthy taxpayers could not avoid income tax by exploiting weaknesses in the tax code. Since the AMT was not indexed for inflation, the number of taxpayers subject to the tax increased dramatically. In 1970, for example, the AMT affected only 20,000 taxpayers. Today, the Urban Institute and Brookings Institution Tax Policy Center estimated about four million taxpayers will owe AMT.
The bill could have been even higher. Without passage of the “fix” as part of the American Taxpayer Relief Act passed in January 2013, an additional 30 million taxpayers would have been subject to AMT.
Six ways clients may be more at risk of owing AMT
There are several key factors to consider when determining whether a client is at risk of owing AMT. Those who may be at higher risk include:
- Clients who live in states with high property or income taxes. These itemized deductions are disregarded when calculating AMT.
- Clients claiming miscellaneous 2% deductions, such as unreimbursed employee expenses. These deductions are not included when calculating AMT.
- Clients reporting a large capital gain. The extra income from capital gains may increase income to a level where the AMT exemption amount would be phased out. For 2013, the income phase-outs begin at $112,500 for individual taxpayers and $150,000 for couples.
- Clients claiming many dependents. Personal exemptions are not allowed when calculating AMT.
- Corporate executives exercising incentive stock options. While exercising the stock option is not considered income, the “spread” between the market price and the exercise price is considered income for AMT.
- Investors who own private activity bonds. The income from this type of municipal bond is not subject to income tax, but is subject to taxation under AMT.
A range of strategies are available to taxpayers to try to avoid or mitigate the impact of the AMT. For example, the timing of certain deductions, such as real estate tax payments, may help. Clients should consult with a tax professional to determine their potential AMT exposure and consider tax-planning options. Advisors can begin a discussion with clients by using the education piece, “The Alternative Minimum Tax: Tax savings strategies.”
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