September 11, 2015
Taxpayers Beware – The Strike of the Alternative Minimum Tax
All Individual taxpayers are subject to two tax systems: the regular income tax and the alternative minimum tax (AMT). Each taxpayer is ultimately liable for the larger of the taxes computed under each system. Because the AMT was originally designed to affect only the super-rich, exemption amounts typically prevent AMT from applying to taxpayers in the lower tax brackets. However, because the AMT exemption amounts are not adjusted for inflation, AMT is now more and more likely to affect moderate earners to whom it was not applicable in the past.
Taxpayers are hit with the AMT if the amount they would have to pay under the AMT system exceeds what they owe under the regular system. It can be triggered by many items including large deductions or the exercise of incentive stock options. The AMT rate is generally 26% or 28%, depending on income level and filing status. Although those rates may seem modest in comparison with the top statutory income-tax rate of 39.6% under the ordinary system, the AMT blunts many common deductions, including state and local income taxes, property taxes, and miscellaneous itemized deductions. For taxpayers with big business expenses, or those living in areas with high state or property taxes, the AMT can lead to costly results.
In addition to taking large deductions, many taxpayers unknowingly incur the AMT by exercising incentive stock options. The AMT rules consider the difference between the exercise price and its market value as taxable income. In other words, you must include the value of the stock you acquire through an ISO exercise (reduced by the option price you paid) in your alternative minimum taxable income in the year that the stock became freely transferable or was not subject to a substantial risk of forfeiture. For regular tax purposes, you would recognize income on the difference between exercise and market price only at the time of sale. Taxpayers should keep in mind that the favorable tax treatment allowed for regular tax purposes when an ISO is exercised (i.e. no taxation at the time the ISO is exercised, deferral of tax of the benefit associated with the ISO until disposition of the stock, and taxation of the entire profit on the sale of stock acquired through ISO exercise at capital gains rates if ISO holding periods are met) is not allowed for alternative minimum tax purposes.
If you qualify for the AMT, you may end up paying more in taxes than you expected and needing to rethink your investment-planning assumptions. The key is to be prepared and devise strategies before the end of the year. Those affected by the AMT sometimes benefit by deferring deductions that aren’t permitted by the AMT, such as state and local tax payment, to the following year, and accelerating income to this year. In any case, planning ahead can prevent the surprise strike of the AMT at tax filing time.
The information provided by Sechrest & Bloom, LLC, is intended to afford general guidelines on matters of interest to taxpayers. The application and impact of tax laws can vary widely, however, from case to case, based upon the specific or unique facts involved. Accordingly, the information provided is not intended to serve as legal, accounting, or tax advice. You are encouraged to consult with professional advisors for advice concerning specific matters before making any decision, and Sechrest & Bloom, LLC disclaims any responsibility for positions taken by taxpayers in their individual cases or for any misunderstanding on the part of a reader.
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