The end of the year is rapidly approaching and for most of us that means tax planning. Historically, this is the time of the year when investment telemarketers and deal makers present their best tax advantage investments.
Buyer Beware! All the best tax investments in the world will not help you avoid the Alternative Minimum Tax - AMT.
Tax investments have long been a key ingredient for wealthy families and individuals to reduce their tax obligations. Sensing something unfair, Congress enacted the AMT regulation which requires many individuals (or their agents) to calculate a return two ways. First, is the traditional method of income minus deductions. The second method, the AMT method, requires adding back almost all deductions and taxing this new gross number by a minimum of 28% (the rate is scheduled to step up to 35%).
The taxpayer is required by law to pay whichever method produces the highest tax dollars. For example, Kenzar Worthington, President and owner of Worthington Imports had a gross income of $1,000,000 and total deductions of $500,000. This meant an adjusted income of $500,000. Kenzar's tax bite in this simple example is around $198,000 (39.6%). Under the AMT method, Kenzar's tax obligation could be as high as $280,000. Assuming these numbers are accurate, Kenzar owes the IRS the greater of the two calculations or $280,000.
Although the AMT code was created to prevent high income individuals or families with lots of write-offs, credits and deductions from paying minimal or, in some cases, no taxes, the gap between the regular tax rate of 39.6% and the highest 1996 AMT rate of 28% may cause taxpayers with relatively small amounts of tax deferred investments to pay the AMT rate. The calculation for AMT is very complicated but do not assume that you are exempt.
Special attention to both the regular and AMT tax effects should be considered if you have the following:
• Tax exempt interest
• Accelerated depreciation
• Bargain element on exercise of incentive stock options
• Gains reported on installment
• Depreciation on property placed in service after 1986
• State, local, real estate, school, etc. tax expense
• Medical deductions
• Charitable contributions
• Itemized deduction
