Executive Summary
Given the wild unpopularity of the Alternative Minimum Tax, and the implicit higher tax burden it carries, it's no great surprise that most people wish to avoid the AMT. However, the reality is that while the actual higher tax burden of the AMT may not be desirable, the tax impact - at the margin- of having more income subject to the AMT can actually be good news!
The inspiration for today's blog post comes from an article by Laura Saunders in the Wall Street Journal this weekend about Four Burning Tax Issues as we approach the end of the year. The article discusses potential legislation between now and the end of the year in the key areas of Income Tax Rates, Qualified Dividends and Long-Term Capital Gains, the Estate Tax, and the Alternative Minimum Tax. The latter is an especially sticky issue for Congress. According to the Tax Policy Center, their analysis of AMT suggests that it may impact approximately 28.5 million taxpayers in 2010, versus 4 million last year, due to a lapse in the temporarily increased level of the AMT exemption back to its early 2001 levels; and notwithstanding a strong desire to fix AMT exposure (at least temporarily for 2010), it is difficult legislation to pass when a "patch" to the AMT exemption for 2010 would cost approximately $75 billion, just for one year!
The focus of today's discussion, though, is not on AMT exposure itself, but the all-too-common tax planning response - that if you're subject to the AMT, you should do whatever you can to defer income so that you don't pay any more AMT. While it is true that almost by definition, being subject to the AMT means your tax liability will be higher than it would have been without the AMT, at the margin being subject to the AMT is actually not bad news in some situations!
The reason is that the AMT system operates with only two tax rates - the "bottom" 26% bracket (on the first $175,000 of income after various AMT adjustments and deductions), and the "top" 28% tax bracket. What's notable is that while your total tax burden may be higher under the AMT system (generally, because of the limitations on deductions and the fact that the bottom tax bracket starts at 26% under AMT and only 10% under the regular tax system), it still has a top tax rate of only 28%, whereas the regular tax system goes as high as 35%, or potentially as high as 39.6% in 2011 if Congress does in fact allow the Economic Growth Tax Relief and Reconciliation Act of 2001 (i.e., EGTRRA, or "the Bush tax cuts") to expire.
Consequently, if you're subject to the AMT this year, it actually might be good news, because you're only subject to a top tax bracket of 28%, compared to a potential 35% or 39.6% next year! Accordingly, for those with higher incomes who might not be subject to the AMT next year, it could actually be better news to accelerate income into 2010, and choose to pay income at "just" 28% AMT tax rates, instead of next year's ordinary income tax rates! Again, even though your current tax liability may be higher due to the AMT, the taxes due on the next $10,000, $50,000, or more income, could actually be lower under the AMT!
This doesn't only apply to higher income folks, either. The bottom tax bracket under the AMT is 26% up to $175,000 of income (after AMT adjustments and deductions), while a similar amount of income could be taxed at 28% (or for some single filers, as much as 33%, depending on deductions); in addition, with the return of the personal exemption and itemized deduction phaseouts in 2011 (unless extended), the actual marginal tax rate of AMT taxpayers in 2011 remains at 26% while regular tax payers could be several percentage points higher.
The important caveat to this is that the AMT exemption itself phases out at higher income levels, starting at $112,500 for singles and $150,000 for married couples. At the margin, income above these thresholds phases out $0.25 for each additional $1 of income. In turn, this means that an extra $10,000 of income received can cause a total of $12,500 of income taxation (due to $2,500 of exemption phaseout), and at a 26% tax rate the individual who earns another $10,000 of income pays another $3,250 in taxes for a 32.5% marginal tax rate. Accordingly, some clients may wish to accelerate income into an AMT year, but probably will only wish to do so if they can either stay below the AMT exemption phaseout threshold, or if their income is so high that they have fully phased out the AMT exemption amount, reverting them "back" to a top AMT tax rate of only 28%.
In the end, it is true that the AMT generally still results in a higher tax liability for most clients. But at the margin, it's still possible that the AMT tax brackets of only 26% and 28% can actually be good news for some clients who can control the timing of additional income (e.g., payment of bonuses, IRA withdrawals, Roth conversions, etc.) at the margin.
Are you doing more AMT planning for your clients? Have you found this tax strategy to be effective in some client situations? Are you doing any special AMT planning in light of the potential that Congress might not extend the AMT exemption?
I call the region where high income taxpayers are in the AMT 28% tax bracket the “AMT sweet spot” and use it agressively. This year it can work well for Roth conversions. Sometimes when clients are just above it, back in 35%, we’ve done charitable contributions down to the top of the sweet spot. It is a surprise to high income – half a million – folks to only be in the 28% level, and not something to be overlooked.
how can charging a specific person more money good or fair?