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October 6, 2016

Is This What You Call An Alternative?

by Team Rowling
Question: What is the Alternative Minimum Tax?

Man carrying a heavy rock with tax etched into it

Answer: The Alternative Minimum Tax (AMT) is a tax designed to ensure that high income people pay their fair share of taxes.

Unfortunately, it is a rather insidious tax that can impact those who aren’t in the top brackets as well. This tax, which can increase taxes above the regular tax amount, can apply to taxpayers with adjusted gross income levels as follows:
• Single or head of household – $53,000 or more
• Married, filing jointly – $83,400 or more
• Married, filing separately – $41,700 or more

Question: How is the AMT an alternative?

Answer: In general, whether or not a taxpayer is subject to AMT is determined by calculating tax twice. “Regular tax” is first calculated with the regular tax system, and then an alternative tax is calculated with the AMT system. You get to pay whichever tax is larger! Not a very good alternative, is it?

Question: How is the AMT calculated?

Answer: Under the AMT, your adjusted gross income (AGI) is increased by certain add-backs and your itemized deductions are reduced by certain deductions that are not allowed for AMT purposes. An AMT exemption amount is then subtracted and the net amount is taxed at the AMT rate. Clear as mud, right? Think of it this way: AMT applies to your regular taxable income without the benefit of many write-offs.

Question: What write-offs are disallowed for AMT purposes?

Answer: Here is a list of typical deductions allowed under the regular tax system, but not allowed (added back) for AMT purposes:
• State and local income taxes
• Real estate taxes
• General sales and personal property taxes
• Home equity interest (“acquisition” mortgage interest on up to $1 million is still deductible for AMT)
• Medical expenses less than 10 percent of AGI
• Miscellaneous itemized deductions
• Personal exemptions
• The standard deduction (for non-itemizers)
Also note that beneficial capital gains rates will not apply to qualified dividends and long term capital gains.

Question: Are there any deductions that are not affected by AMT?

Answer: Yes. Whether or not you are subject to AMT, you will receive full benefits for making charitable contributions.

Question: How can I avoid AMT?

Answer: Avoiding or planning for AMT is often difficult because there is no intuitive way of knowing if it will apply. In general, if you have a high ratio of itemized deductions (state income taxes, property taxes and miscellaneous itemized deductions) compared to ordinary income (income that is not long term capital gain income), you might be subject to AMT. If you believe you will be subject to AMT, typical year-end tax moves won’t make sense. Prepaying property taxes or state income taxes won’t lower your taxes. So, if you’ll be in AMT, postpone those deductions until next year.

The Bottom Line

Having a good tax planning strategy in place ahead of time is your best defense. Be sure to enlist the assistance of a qualified tax advisor – like Rowling & Associates!

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