Navigating tax law is always tricky, but
the Alternative Minimum Tax (AMT)
further complicates the question most business owners want to know at year’s
end: How much do I really owe?
Many individuals never hear of AMT
until, perhaps, they receive a notification
alerting them that they owe AMT in addition to already paid yearly income taxes.
This “alternative” tax was designed to level
the tax playing field so high-income individuals could not deduct away their entire
tax payment with special exemptions and
deductions. But changes in AMT deduction
allowances or more likely disallowances find more middle-class individuals paying the tax.
“The problem with AMT is the complexity in calculating it and the additional
record-keeping requirements,” says Steve
Magovac, associate director for SS&G
Financial Services, Inc. in Cleveland and
Akron. “Even a seasoned businessperson
will have difficulty keeping up with the
adjustments and requirements.”
Smart Business asked Magovac about
changes in AMT law and how these affect
individuals and business owners.
What is the Alternative Minimum Tax, and
when is it applied?
The AMT was designed as an ‘alternative’
income tax code, and it runs parallel to the
income tax. Its rules determine the minimum amount an individual should pay. To
figure AMT, a person calculates his or her
taxable income according to regular tax
code, applying deductions. Then, individuals must figure out the AMT according to
their AMT taxable income.
For example, if an individual calculating
$2,000 in regular income taxes and $2,500
in AMT, the person must pay the higher of
the two. That $500 difference is called
AMT. Generally, AMT comes into play
when deductions reduce regular income
tax to a point that the AMT is higher.
Who is subject to AMT?
Everyone is required to calculate it. The
AMT used to be a factor only to high-income individuals, but today, many middle-class business owners who are taking
advantage of income tax deductions find
that their AMT is higher. Regular income
tax deductions continue to adjust with inflation, but the AMT exemption is decreasing and deductions are not available
for certain items. For example, an individual living in a high-taxing jurisdiction, like
Ohio, cannot take a deduction for state
taxes when filing AMT; the resident can
deduct those taxes for regular income tax.
What income tax deductions may cause an
individual to be liable for AMT?
Many of the deductions an individual can
take on income tax do not apply to AMT.
As noted, individuals can deduct state and
city taxes from regular income tax, but
AMT will not allow the deduction. Also,
married couples filing jointly could take an
AMT standard income tax deduction of
$62,550. However, for 2007, the AMT
exemption was reduced to $45,000.
Furthermore, many tax credits will not be
allowed to reduce the AMT, such as
dependent care and education credits.
The key point is that AMT does not make
the allowances that income tax does regarding deductions and benefits, negating
many positive changes in income tax law.
What changes to AMT should individuals and
business owners understand?
A positive outcome of the 2006 Tax Act,
effective for 2007, was AMT credits.
Individuals who paid AMT could earn a credit applicable to the following year’s
AMT. For example, an individual who paid
$500 in AMT the difference between
$1,500 in income tax and $1,000 in AMT
could earn a $500 credit in certain situations. This credit could apply only to items
considered temporary AMT adjustments,
such as investment stock options or depreciation. Say a person depreciated a computer. Because there are different depreciation methods for both income and AMT, a
portion of the taxed amount could convert
to a credit. According to the pre-2007 AMT
rules, the credit could only be applied to
regular tax, and the AMT credit was not
allowed to decrease the AMT, so it was
very difficult to take advantage of these
However, the 2006 Tax Relief and Health
Care Act loosened the rules on how individuals could apply AMT credits. Those
with unused AMT credits, dating back
three years or later, now have the ability to
reduce their regular AMT.
Are there changes that do not benefit taxpayers?
In general, the AMT has not modified its
rules to keep up with regular income tax
changes. For example, in 2006 and earlier,
individuals who earned Dependacare credits, education credits, energy credits and
mortgage interest credits had the ability to
reduce both regular income tax and AMT.
Starting in 2007, these credits apply only to
reduce regular income tax. This means
individuals taking advantage of these credits will not truly get a tax break if they are
subject to the AMT. We anticipate legislative relief during later months of 2007. It’s
our hope that the political environment
will drive change.
What solutions can tax professionals provide
individuals who face potential AMT for the
2007 tax year?
The key is tax planning, which should be
an ongoing process. Meet with the professional who prepares your taxes well before
year’s end to discuss whether AMT is likely. This can determine whether an individual takes accelerated deductions.
STEVE MAGOVAC is an associate director in the tax department
at SS&G Financial Services, Inc. in Akron. Reach him at (330)
668-9696 or [email protected].