Saving your investments from Alternative Minimum Tax trap

June 19, 2014

 

calculatroI discuss investing strategies in this column, but this month I’m addressing a change in the tax code you should be aware of so you can hang on to your hard-earned savings. The American Taxpayer Relief Act of 2012 permanently adjusted the alternative minimum tax (AMT) with new exemption levels that will be indexed annually for inflation. Prior to the fix, lawmakers used annual “patches” to help prevent the tax from hitting many more unsuspecting households. The new legislation will save nearly 27 million people from the AMT for the 2013 tax year, but that doesn’t mean middle-income taxpayers can rest easy. About 3.4 million taxpayers could still be affected. Because indexing the AMT doesn’t protect taxpayers as their real income grows, the Tax Policy Center projects the number of AMT taxpayers will increase 35 percent by 2018. If you are wondering whether the AMT could increase your tax burden in the coming years, you might be interested in the following details and some strategies that could help minimize its potential effects. AMT parameters The AMT is a parallel tax system that eliminates many of the deductions, exemptions, and credits often used by taxpayers to reduce their tax bills under the normal rules. Consequently, more income may be taxable under the AMT. Taxpayers with incomes above the indexed exemption amounts ($51,900 for single filers and $80,800 for married joint filers in 2013) must calculate their income taxes under both sets of rules and pay the higher of the two. AMT rates range from 26 percent to 28 percent, compared with federal income tax rates that step up from 10 percent to 39.6 percent. However, the AMT doesn’t allow filers to claim personal exemptions, the standard deduction, or many other popular itemized deductions (including state, local, or property taxes). Ironically, wealthy taxpayers in the top tax bracket — the original targets of the AMT — may be able to take advantage of more tax breaks than middle-income taxpayers who fall into the grasp of the AMT. Who is at risk The more exemptions and deductions that taxpayers normally claim, the more vulnerable they may be to the AMT. Any of the following circumstances could trigger AMT liability:

  •         Gross income above $100,000
  •         A large number of personal exemptions, such as dependent children
  •         Incentive stock options exercised during the year
  •         A large capital gain
  •         Passive income or losses
  •         Income from private-activity bonds
  •         Significant itemized deductions, including state and local taxes (especially for residents of high-tax states), home-equity loan interest, and deductible medical expenses

Managing exposure Some one-time gains and large deductions can be controlled, so looking ahead could help you reduce the impact of the AMT. For example, you might be able to delay an asset sale or spread out the gain by structuring payments in installments. You could also exercise incentive stock options strategically and/or choose to take certain itemized deductions in years when you won’t face the AMT. Despite talk of broader tax reform, the U.S. tax code seems to become more complicated every year. Before you take any specific action, be sure to consult with your tax professional.

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