Originally published on Forbes.com Nov 1st, 2013
You can do a lot more to affect your tax liability for the year in November and December than you can in April of the following year. Often you will have enough information to do a pretty good mock-up of your return, which will then allow you to do some what-ifs. It might be tempting to do planning based on the theory that your marginal tax rate is x percent so that paying y dollars on a deductible item will save you xy dollars.
Don’t do it. Unless your life is very simple you really need to set up your pro-forma tax return and run through the complete computations. (Or have somebody do it for you.) There are just too many thresholds and phase-outs and odd interactions in the tax code. Probably the biggest thing that will cause simplistic tax planning to crash and burn is the alternative minimum tax (AMT).
AMT For The Uninitiated
To help you understand what is going on with AMT, take a look at the forms. If you hire somebody to do your return, that might be a daunting prospect, since you have a package that might resemble a small book. Also it may be that you did not happen to be in AMT last year. There are only two forms I am going to refer to and only a couple of lines on each, so it will not hurt too much. The forms are 1040 and 6251. It might help to open them up. That is why I gave you links.
On Form 1040 if you go to Line 44 you will see “Tax” which is followed by Line 45 “Alternative Minimum Tax”. Line 46 is the sum of the two previous lines. That makes it look like AMT is an “extra tax” that is added to your regular tax. Although that may be true in a formal sense, it is misleading.
Take a look at Form 6251 which feeds into Line 45 of the 1040. Line 33 is your “Tentative Minimum Tax”. On Line 34 you subtract an adjusted version of the “Tax” from Line 44 of the 1040 to arrive at the AMT. I’m sorry that I can’t make it simpler, but it is important to recognize this. That AMT on Line 35 of Form 6251 that is carried to Line 45 of Form 1040 is actually what accountants call a plug. The number that is going on Line 46 of the 1040 as the income tax before credits is either the regular tax or the tentative minimum tax, whichever is higher. More on the credits later. Here is the key insight.
Which Country Do You Live In – AMT Or Regular?
Look at those two numbers the “Tax” from Line 44 of 1040 and the “Tentative minimum tax” from Line 33 of 6251, the difference between those two numbers represents how far you are from the border of two countries. In the country of Regular Tax, rates are higher but there are more deductions and exclusions and faster depreciation schedules. In AMT Land rates are lower, but there are fewer deductions and exclusions and slower depreciation schedules. If the regular tax is much higher than the “Tentative minimum tax”, then simplistic tax planning might work OK. You should still run through the full computation because all the thresholds and phase-outs and the passive activity loss rules can create odd situations that you might find counter-intuitive.
Now The Hard Part
If you are deep into AMT country, is there much you can do? Well, the first thing you can do is to avoid wasting deductions. Take a look at that Form 6251 again. In computing your Alternative Minimum Taxable Income (AMTI), it starts with Line 41 of your 1040, which is unlabeled. Essentially it is your regular Taxable Income, with exemptions added back. So if you are divorced or separated or coparenting by some other means, let the coparent have the exemptions for the kids.
Remember that a non-custodial parent needs Form 8332 in order to claim the exemption. So if you are the custodial parent you will fill it out and if you are the non-custodial parent you will tell your coparent not to bother. It is possible that this move might cost you a bit in state income taxes, so you should probably ask them for a couple of hundred bucks to make you whole, unless they are really dumb, in which case you should ask for a couple of thousand.
Next focus on lines 2, 3, and 5, mostly line 3 -]Taxes. We are not talking about federal taxes here we are talking about the state income taxes (or sales tax), real estate tax, and personal property tax. Taxes are deductible against regular taxable income but are added back for AMTI. You control the timing of those payments.
So if you are deep into AMT country, wait until January to pay your fourth quarter state income estimate and your real estate taxes even if it costs you a small penalty. Those deductions will not help you in 2013, but maybe they will do you some good in 2014. On the other hand, if AMT land is far, far away accelerate those deductions into 2013.
Make a very big fourth-quarter estimate on your state income taxes and pay it in December. In Massachusetts, for example, towns are on a June year-end, so you will be able to make the real estate tax payments due in the first half of 2014 in December of 2013. If you are in a low or no-income-tax state, you might want to accelerate or slow down a purchase that will create a big sales or use tax payment.
Miscellaneous deductions follow a similar principle except that you have to keep in mind that they are subject to a 2% of AGI floor for regular taxes. If you have a big legal bill that is related to the production or preservation of income, you can decide whether to pay in 2013, if you are firmly in regular tax country, or 2014 if you are in AMT land.
What About Those Other Twenty Or So Lines ?
Here is the thing. AMTI is not just a couple of tweaks to the regular tax. It is a complete parallel system. The numbers near the top of the form are items that are never deductible for AMTI, but most of the rest of the numbers are about timing. Generally, you get to deduct things faster in Regular Tax Land. That means that many of the numbers on Form 6251 can be negative. You have different carryovers of passive activity losses for AMT, different net operating loss carryovers. You might have a different capital loss carryover. And of course, you have a different basis in assets.
If you are in Regular Tax Land, nobody is going to care about those negative numbers, unless they are really anal. Comes the year when you are all of a sudden deep into AMT country, it would really be great if you could post some big negative numbers on that Form 6251. There is a problem, though.
An Ugly Truth About Tax Preparation
Suppose that you were a shareholder in an S corporation. Every year you received a K-1 which showed you how much income was flowing through to you. There were also numbers representing AMT adjustments depreciation almost for sure, but possibly odd things like research and development expenses. In all those years you never paid AMT so nobody ever worried much about those numbers. In 2013 you sold your stock in the S corporation. When you do your pro-forma return you find that you are deep into AMT Land.
Wouldn’t it be great to have a nice big negative number somewhere on your Form 6251? Well, you are entitled to one. It goes on Line 17 of Form 6251. It is the difference between the regular tax basis of your S corporation stock and the AMT basis of your S corporation stock. Surely you have been keeping track of your AMT basis in your S corporation stock.
Oh. You rely on your accountant for things like that. Well, I have to tell you. Your reliance is misplaced. If you have had the same accounting firm for all the years that you owned the S corporation and they used a good software package like Pro fx continuously for all those years, there is a chance that the number is available. If you switched preparers several times and they switched software, the chance that you have a good AMT basis number is pretty remote.
Personal net operating losses are not that common, but they do happen. A common problem you will see when you enter a personal net operating loss is all of a sudden a huge AMT. That is because you also have to enter the AMT NOL, which is likely a different number. If the return has changed hands enough, reconstructing that can be quite a challenge.
What you need to do if you are facing a big AMT liability is to closely scrutinize your returns for the last several years to see if there might be some favorable adjustments being overlooked. If you think that there is somebody doing this as a matter of course, you are probably kidding yourself.
How To Be In AMT Without Knowing It ?
Many credits against regular tax are limited by AMT. If that is happening to you you will not see AMT liability on your 1040. It will show up in the detailed computations of the limitation on your credits. I was going to give you some forms and line numbers to illustrate that point, but if you have gotten this far you probably have a headache.
I’m hoping that I get some commenters who tell me that they keep meticulous track of all AMT carryovers for their clients and do a detailed reconstruction whenever they take on a new client. I bet they floss regularly too.
You can follow me on twitter @peterreillycpa.
Note
When I discussed this article with someone whose opinion I value, he questioned whether, in fact, you do get a different basis in your S stock for purposes of computing AMTI. It turns out that nailing that question down is pretty challenging, so I am not going to try to explain why I still hold that conclusion, even while admitting that someone might question it. I could have substituted a less controversial example to make the point, but I am letting it stand as something that some commenters might want to discuss.
When Planning Never Forget The Alternative Minimum Tax
