EFFECTIVELY GONE

While the GOP Tax Act did not do away with the dreaded Alternative Minimum Tax (AMT) for individuals, it is as good as gone.

First, some background.

The AMT (a more appropriate name would be the Mandatory Maximum Tax) was originally enacted in 1969 in response to testimony by the Secretary of the Treasury that 155 individuals with Adjusted Gross Income of more than $200,000 (over $1 Million in today’s dollars) paid “0” tax on their 1967 tax returns. Congress received more letters that year on the Secretary’s testimony than they did on the Vietnam War!

Of course, Congress, being lazy idiots, rather than responding by acting logically and eliminating the loopholes in the Tax Code that allowed the high-income individuals to avoid paying tax, reacted and created a complicated alternative tax system.

The tax was originally just a “Minimum Tax” (back when I started in “the business” there was also a 50% “Maximum Tax” on earned income).  It was calculated on Form 4625 and reported in the “Other Taxes” section of the 1040.  Beginning with the 1979 Form 1040 the an “Alternative” Minimum Tax reported on Form 6251 was added to the Minimum Tax.  The Minimum Tax was repealed in 1982, leaving just the “Alternative” version effective with 1983 tax returns. 

The passive activity and other rules included in the Tax Reform Act of 1986 effectively closed many of the loopholes used by the wealthy to avoid taxes that had led to the creation of the Maximum Tax in the first place.  But instead of doing away with it, as should have been done, the Act revised it into a kind of “stealth tax” to deceive the American public.  We were told that TRA 86 would reduce and, to a degree simplify, taxes for all – which it did under the “regular” income tax.  But what Washington gave with one hand via the regular tax they took back from the middle and upper middle class with the other hand via the revised AMT.

My clients, and those of my mentor, first became victim of the AMT in the early 1990s.  In the new millennium I have had to at least check the AMT exposure of about 2/3 of my clients each year.  To be sure the pre-TCJA AMT did not affect the truly wealthy – the so-called 1%.  It took its toll on the middle and upper middle class, especially penalizing families in highly taxed states (like NJ). 

The “preferences” of the AMT, added back to “regular” taxable income to determine Alternative Minimum Taxable Income (AMTI), that usually made taxpayers victims of the dreaded tax were –

* Personal Exemptions

* Medical Expenses (the AMT exclusion was 10% of AGI instead of 7.5%)

* Taxes

* Home Equity Interest

* Miscellaneous Expenses subject to the 2% of AGI exclusion (employee business expenses, investment expenses, tax preparation costs, legal fees)

None of these items were deductible in calculating the AMT.

Under the GOP Tax Act, for 2018 through 2025 I expect none of my clients will be victims of the AMT.  Why? 

* The Personal Exemption deduction is repealed.

* The medical expense AGI exclusion (beginning in 2019) is 10%.

* Home equity interest and miscellaneous expenses (subject to the 2% exclusion) are no longer deductible.

* The itemized deduction for taxes is limited to $10,000.

It is interesting how the “new” 1040 follows closely the “old” AMT rules for deductions (originally taxes were not going to be deductible at all – but the $10,000 was added to appease Republican Congresscritters from highly taxed states).  I had heard that one option being considered for “tax reform” was replacing the “regular” tax system with the AMT system for all taxpayers.   

Pre GOP Tax Act, the AMT “exemption” was reduced, and eventually phased out altogether, as AGI, and therefore AMTI, increased beginning at a relatively low threshold.  So, for example, while qualified dividends and long-term capital gains were taxed at special lower rates for both regular tax and the AMT, this income increased AGI, and AMTI, and could reduce the AMT exemption.  But now the phase out begins at $500,000 for unmarried taxpayers and $1,000,000 for married ones.  So this will not be an issue for my clients. 

The changes to the AMT make up for losing substantial deductions for exemptions and property and state income taxes, which were not deductible anyway in the old AMT, for many of my highly taxed NJ clients.

So, while the Act did not do away with the AMT altogether, thankfully it actually did away with it for most taxpayers. 

TTFN

TAXES AIN'T FAIR!

Tax reform has become a hot political topic.  Reduce taxes on the middle class, or increase taxes on the “wealthy” simply because they can afford it.

 

I see a great need for substantive tax reform not to reduce, or for some taxpayers increase, the actual amount of taxes paid – but to simplify the Tax Code and make it more fair.

 

Nobody ever said taxes are fair.  There are many inequities in the US Tax Code, some purposeful and some unintended.

 

Among the biggest inequities concerns how the Code treats some aspects of “gross income” and expenses related to generating this income.  I speak specifically of the taxation of gambling winnings and legal settlements.

 

If you have gambling winnings you must report, in most cases (how to report some winnings is a topic for another post), the gross winnings as income on Page 1 of the Form 1040.  This is the amount that is reported on Form W-2G.  So gross winnings are included in Adjusted Gross Income (AGI).  But gambling losses, to the extent of winnings reported, are deducted as a Miscellaneous Deduction on Schedule A if you are able to itemize (although not subject to the 2% of AGI exclusion).

 

Similarly, the gross amount of legal settlements, except for settlements for physical injuries or sickness (any damages or settlement you receive to compensate you for your medical expenses, lost wages, and pain, suffering, and emotional distress is not included in income), is included as income on Page 1 of Form 1040.  The legal fees, often as much as 1/3 of the settlement, and other related are also deducted as a Miscellaneous Deduction on Schedule A if you are able to itemize (in this case the deduction is subject to the 2% of AGI exclusion).

 

A taxpayer can have $5,000 in gross winnings from gambling activities for the year, but $6,000 in gambling losses.  So, the taxpayer’s gambling activity for the year has resulted in a loss.  The taxpayer ended up with no money “in pocket’ from gambling. 

 

If the taxpayer is able to itemize without taking into effect the allowed gambling losses, the Schedule A deduction for $5,000 in gambling losses results in net taxable income of 0 – so, in effect but not necessarily in reality, he/she does not pay federal income tax on the winnings.  But if the taxpayer is not able to itemize, even with the gambling loss deduction, or if he/she is only able to itemize because of the gambling loss deduction (without the deduction his itemizable deductions do not exceed the applicable Standard Deduction), he/she will be paying federal income tax on up to $5,000 of income that was not actually received – in the 25% tax bracket $0 in net gambling income could cost the taxpayer at least $1,250.

 

Similarly, with a taxable legal settlement, the need to deduct legal fees as a miscellaneous itemized deduction subject to the 2% of AGI exclusion could result in federal income tax being paid on more than the actual “in pocket” amount.

 

Of course, a large portion of the inequity comes from the fact that various items of income are increased and deductions and credits are reduced or eliminated based on one’s AGI.  And the fact that most itemized miscellaneous deductions are not allowed in calculating the dreaded Alternative Minimum Tax (AMT).

 

While a taxpayer may be able to wipe out gambling winnings with fully deductible gambling losses, the fact that gross winnings are included in AGI could result in more of the taxpayer’s Social Security or Railroad Retirement benefits (the amount of benefits taxed is determined by a formula that is based on AGI) being taxed – many frequent gamblers in the casinos of Atlantic City for example are senior citizens – or could reduce or totally eliminate allowable tax deductions or credits.  So again, the taxpayer is in reality paying federal income tax on $0 in net income.

 

The same is possible with a taxable legal settlement – except for settlements for discrimination claims, the related legal fees allowed as an “adjustment to income” which reduces AGI.  And, while there may be no excess tax under “regular” income tax rules there may be AMT.  Allowable gambling losses from Schedule A are fully deductible in calculating the dreaded AMT – but because legal fees are a miscellaneous deduction subject to the 2% of AGI limitation they are not deductible in calculating AMT.  So, tax is paid on the full amount of the gross settlement at a flat 26% or 28%.  When adding the federal and state tax to the legal fees the taxpayer may end up with only 1/3 or less of the actual award “in pocket”.

 

And while in many cases net and not gross gambling winnings are taxed under AMT, the fact that gross winnings are included in AGI, and therefore Alternative Minimum Taxable Income (AMTI), could reduce the AMT exemption, resulting in AMT tax on gambling winnings even if the net is 0.  $5,000 in gross winnings can reduce the AMT exemption by $1,250 and result in an additional $325 or $350 in AMT.

 

The AMT issue would go away if tax legislation repeals this tax.  And changing the way Social Security and Railroad Retirement benefits are taxed and no longer allowing AMT to affect tax deductions and credits would also help to remove inequities.  But the best way to do away with the unfairness of the tax treatment of these two types of income would be allowing taxpayers to net gambling losses against gambling wins (still not allowing the deduction of more losses than wins) and net legal fees against gross settlements – either directly by entering the net amount on Page 1 or by allowing the deductions as an adjustment to income reducing AGI – would certainly fix the problem.

 

So, what do you think?

 

FYI – I will post on other inequities in the current Tax Code in future posts.

 

TTFN

 

 

 

 

 

 

IT AIN’T NECESSARILY SO – AMT EDITION

Here is something that you should know if you are or will be a victim of the dreaded Alternative Minimum Tax (AMT) – which I recently had to explain to a client who was a victim for 2015.

The “published” AMT tax rates are 26% and 28%.  But the true “effective” tax rates could actually be 32.5% and 35%.

Your AMT exemption, based on your filing status, is reduced by 25% for every dollar that your Alternative Minimum Taxable Income (AMTI) exceeds a specific threshold amount, again based on your filing status.

For 2016 the AMT threshold amounts are –

•    $119,700 – Single and Head of Household

•    $159,700 – Married Filing Joint and Qualifying Widow(er)

•    $ 79,850 – Married Filing Separately

The AMT base exemption amounts are –

•    $53,900 - Single and Head of Household

•    $83,800 - Married Filing Joint and Qualifying Widow(er) 

•    $41,900 - Married Filing Separate 

So if you are filing a joint return and your MAGI is $169,700 you reduce your exemption, and increase the income subject to AMT, by $2,500.  The exemption allowed will be $81,300 and not $83,800.  So you will be paying AMT on $88,400.

If your MAGI was $159,700 you would get the full exemption of $83,800 and pay AMT on $75,900. 

The additional $10,000 in income increases the amount of income subject to AMT by $12,500.  In the 26% AMT bracket that $10,000 of excess income cost you $3,250 in federal tax ($12,500 x 26%), or 32.5%. 

Of course there does come a point when the level of your AMTI totally wipes out the allowable exemption.  Once you reach this point additional income is effectively taxed at the published rate of 26% or 28%.

Any questions? 

TTFN

 

 

 

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TRAPPED BY OUR CAPITAL GAINS ARE WE

We all know, or at least many of us know, that long term capital gains (gain on the sale of investments held more than one year and capital gain distributions from mutual funds) and qualified dividends are taxed separately at special lower rates.  Those in the 10% and 15% brackets pay 0% tax on this income, those in the 25% - 35% brackets pay 15%, and those in the top 39.6% bracket pay 20%.  And that these applies to both the “regular” income tax and the dreaded Alternative Minimum Tax (ATM). Right?

 

Well it ain’t necessarily so {wow! 2 Broadway musical lyric references in one post!}.

Long-term capital gains and qualified dividends are reported as taxable income on Page 1 of the Form 1040 and are included in Adjusted Gross Income (AGI).  There are a multitude of deductions and credits that are reduced, phased out, or disallowed based on one’s AGI.  These include:

•  deductible traditional and spousal IRA contributions,

•  the ability to contribute to a ROTH IRA,

•  student loan interest,

•  the deduction for tuition and fees (if extended)

•  medical and dental expenses,

•  charitable contributions,

•  casualty and theft losses,

•  miscellaneous itemized deductions,

•  total Itemized Deductions,

•  the deduction for personal exemptions,

•  the Credit for Child and Dependent Care Expenses,

•  the Credit for the Elderly or Disabled,

•  the American Opportunity and Lifetime Learning education credits,

•  the Retirement Savings Contributions Credit,

•  the Child Tax Credit,

•  the Adoption Credit,

•  the Earned Income Credit, and

•  Coverdell Education Savings Account contributions.      

And as AGI increases so does the taxable portion of Social Security and Railroad Retirement benefits, and the deductible loss from rental real estate is reduced or phased out.

In the case of Social Security and Railroad Retirement benefits, an additional $1.00 of AGI can increase taxable benefits by as much as 85 cents.  So capital gain and qualified dividend income for a taxpayer in the 25% bracket could be effectively taxed at 21.25%, as an additional $1.000 in such income could increase taxable income by $850.

And even $10 in such income could cause a taxpayer to lose a $2,000 deduction for tuition and fees, if extended, and cost $500 in taxes in the 25% bracket.

Even though long-term capital gain and qualified dividend income is taxed separately at the special rates under the dreaded AMT, since this income increases AGI it also increases Alternative Minimum Taxable Income (AMTI), and could reduce the amount of the allowable AMT exemption.  $1,000 of such income could increase income subject to the 26% AMT tax by $250 and cost an additional $65.00.

And we all, or many of us, know that only $3,000 in net capital losses can be currently deducted on the Form 1040.  Any excess losses are carried forward to subsequent years.  If the total net loss for 2015 was $10,000, $3,000 is deducted in 2015 and $7,000 is carried forward to 2016.  So the loss is not lost.

 

But this is not the case on NJ or PA state income tax returns (I don’t know of any other states offhand).  These states do not allow any carryforward of capital losses.  So the $7,000 mentioned above is truly lost when it comes to state income tax.  Actually the entire $10,000 in losses are lost – as these states have a “gross” income tax system and do not allow capital losses from the sale of investments to reduce income in other categories.  

 

I am not saying to avoid long-term capital gains or losses.  The first criteria for evaluating any transaction, strategy, or technique you are considering should always be financial.  Taxes are second.  Never let the tax tail wag the economic dog.  Sell a stock or mutual fund shares for the best possible price.  By postponing a sale to meet the long-term criteria or to avoid having to report the income or losses on your tax return the price of the investment could drop and give you a smaller profit or greater loss.

Just be mindful of what I have discussed above, be aware of the true cost of your capital transactions, and consider increasing estimated tax payments or withholding if appropriate.  And consider harvesting losses to offset gains or engaging in a “wash sale” of investments that would generate a gain to offset losses at year end. 

It would be a good idea to discuss actual and planned investment activity with your tax professional periodically during the year, and especially at year end. 

THE FINAL WORD –

I am sorry – I cannot resist.

Speaking of it ain’t necessarily so.  The things that you're liable to hear from Donald Trump, it ain't necessarily so.

TTFN

TRY TO REMEMBER . . .

The summer is almost over – and year-end tax planning time will soon be here.

Just thought I would provide some 1040-related reminders –

MORTGAGE INTEREST

Basically there are two types of mortgage debt –

1) Acquisition debt - debt acquired after October 13, 1987, that was used to buy, build, or substantially improve a main residence or a qualified second home. A “substantial improvement” is one that adds value to the home, prolongs the home’s useful life, or adapts the home to new uses.  And

2) Home equity debt – debt acquired after October 13, 1987, that is secured by a main residence or a qualified second home that is not used to buy, build, or substantially improve the property.  There is no restriction or limitation on what the money can be used for; you can use it to buy a car, to pay for college, or to pay down credit card balances. 

You can deduct interest on acquisition debt principal of up to $1 Million.  But you can only deduct interest on home equity debt principal of up to $100,000.  When you refinance a mortgage, or consolidate mortgage debts, any closing costs that are added to the principal of the loan are considered to be home equity debt.

It is very important that you keep good records of their separate acquisition debt and home equity debt so that the correct amount of mortgage interest is claimed on Schedule A. 

ALTERNATIVE MINIMUM TAX

Speaking of home equity interest - in calculating the dreaded Alternative Minimum Tax (AMT) only interest on acquisition debt – mortgage loan proceeds used to buy, build, or substantially improve a primary and one secondary residence - is deductible.  Interest on home equity debt is not deductible. 

It is very important that you keep good records of their separate acquisition debt and home equity debt so that the correct amount of mortgage interest is claimed on Form 6251. 

{FYI - my “Mortgage Interest Guide” - available from my DOLLAR STORE - includes worksheets, with complete instructions and detailed examples, for keeping track of acquisition debt and home equity debt.}

ADDITIONAL STATE TAX DEDUCTION

You can deduct mandatory employee contributions to a state unemployment (SUI), disability (SDI), and/or family leave fund (FLI) which are withheld from your paycheck, as is the practice in Alaska, California, New Jersey, New York, Pennsylvania, Rhode Island, and Washington, as state income tax on Schedule A. 

The amount of the withholding is usually reported on your W-2 in Box 14.  If not you can find the amount on your year-end cumulative paystub.

I deduct these withholdings as “other tax” on Line 8 of Schedule A to separately identify them.

If you elect to deduct state and local sales tax instead of state and local income tax you cannot deduct these withholdings.

CHARITABLE CONTRIBUTIONS

If the total amount donated to a church or charity is more than $250.00 you must have a “contemporaneous” written acknowledgement from the organization with its name and address, the date of the contribution, and the amount donated.   

To be able to claim a deduction for the full amount of your contribution the acknowledgement must state “No goods or services were provided in exchange for the donation”.  It is very important that this statement is included on your receipt or acknowledgement.  And the receipt or acknowledgement must be received from the church or charity before the earlier of the date the original tax return is filed or the extended due date of the tax return.

{FYI – my DOLLAR STORE also has a “Charitable Contributions Guide” with worksheets.  Order any 2 guides from the Dollar Store by September 15^th and receive “Surfing USA” free!}

BUSINESS TRAVEL

If you use your car for business you must keep “contemporaneous” records of your business mileage. This means that you should record the information on the day the trip occurs.  Record each individual business trip separately. Enter the date, location, business purpose and miles driven for each trip in some kind of diary, account book, or expense log. If you do not have EZ Pass you should also note any toll expenses. If you do have EZ Pass, you can identify tolls for business trips on the monthly statement.

I use a pocket date book as my travel log.  I also enter in my travel log the quarter I put in the parking meter while visiting a client.

{You guessed it – the DOLLAR STORE also has a “Business Expense Guide”.}

TTFN

DEDUCTING MORTGAGE INTEREST

In my opinion the area of the Tax Code where proper documentation and strict adherence to the law is perhaps the most overlooked (or actually ignored) is the deduction for mortgage interest – both on Schedule A and Form 6251 (Alternative Minimum Tax-Individuals).

As a reminder – there are three (3) kinds of mortgage debt –

1) Grandfathered debt – debt acquired on or before October 13, 1987, that was secured by a main residence or a qualified second home.  It does matter what the proceeds of the loan were used for, as long as the debt was secured by the property.

2) Acquisition debt - debt acquired after October 13, 1987, that was used to buy, build, or substantially improve a main residence or a qualified second home. A “substantial improvement” is one that adds value to the home, prolongs the home’s useful life, or adapts the home to new uses.

3) Home equity debt – debt acquired after October 13, 1987, that is secured by a main residence or a qualified second home that is not used to buy, build, or substantially improve the property.  There is no restriction or limitation on what the money can be used for; you can use it to buy a car, to pay for college, or to pay down credit card balances. 

Interest on home equity debt is not deductible in calculating the dreaded Alternative Minimum Tax (AMT)

Taxpayers are required to keep separate track of acquisition debt and home equity debt, to make sure that the deduction on Schedule A does not include interest on debt principal that exceed the statutory maximums ($1 Million for acquisition debt and $100,000 for home equity debt – no limit on grandfathered debt), and to determine what interest deduction to add back on Form 6251 when calculating Alternative Minimum Taxable Income.

I firmly believe that 99.5% of taxpayers do not do this.  I do not know of any taxpayer who does. 

And I expect that the majority of tax preparers do not do this for their taxpayer clients.

Most taxpayers, and a large percentage of tax preparers, merely take the amount of “Mortgage interest received from payer(s)/borrower(s)” reported in Box 1 of the Form 1098 Mortgage Interest Statements and enter it on Line 10 of Schedule A. 

And similarly, most taxpayers, and a large percentage of tax preparers, do not include any adjustment to the Schedule A mortgage interest deduction on Line 4 of Form 6251.

It is sometimes easy to identify the difference between acquisition debt and home-equity debt if the taxpayer has one acquisition mortgage and a separate home equity loan and/or line of credit.  But home equity debt often arises from multiple refinancings and consolidations over an extended period of years.

To be fair to my fellow tax preparers, many do not adjust the Schedule A or Form 6251 deduction for home equity interest because their clients have not kept track of the separate types of debt and therefore do not provide separate principal or interest numbers.

The responsibility for keeping separate track of the two types of mortgage debt (actually three if you consider “grandfathered” mortgage debt) truly lies with the taxpayer client and not the tax preparer.

Obviously the best solution to this issue is to have boxes on the Form 1098 for “acquisition debt” principal and interest and “home equity debt” principal and interest, and require banks and other mortgage providers to properly report these amounts thereon.  But this would require a lot more information gathering and paperwork on the part of mortgage providers, and I doubt if the banking lobby would allow a law requiring this additional reporting to pass.

I have created a “Mortgage Interest Guide” as part of my Dollar Store of Tax Guides.  In this guide I explain the various types of mortgage debt and the deduction limitations, and go into detail on how refinancing an acquisition debt mortgage can result in home equity debt. 

I also include in this guide two worksheets – one for Acquisition Debt Activity and one for Home Equity Debt activity – and provide a detailed example of how to use the debt activity worksheets.  These worksheets will allow homeowners to keep a detailed record of the two types of mortgage debt – so that they will be able to properly complete their tax returns, or to provide the necessary information to their professional tax preparers.

As one would expect, the cost of this Mortgage Interest Guide, sent as a pdf email attachment, is only $2.00!  A printed copy sent via postal mail is $4.00.  {Check out my other Tax Deduction Guides}

Send your check or money order for $2.00, or $4.00, payable to TAXES AND ACCOUNTING, INC, to –

MORTGAGE INTEREST GUIDE

TAXES AND ACCOUNTING INC

POST OFFICE BOX A

HAWLEY PA 18428

TTFN

MORE CLIENTS SCREWED BY THE TAX CODE

Recipients of Social Security and Railroad Retirement benefits are not the only taxpayers who are screwed by the US Tax Code (see this post). 

Most of my clients are from New Jersey.  I have several two income families whose W-2 incomes are inflated because of the high cost of living and whose biggest tax deduction is the combination of real estate and state income taxes.  As a result, they are often victims of the dreaded Alternative Minimum Tax (AMT).

Taxes of any kind are not deductible in calculating AMT, and neither are personal and dependent exemptions, home equity interest, or Miscellaneous Expenses subject to the 2% of Adjusted Gross Income (AGI) exclusion (employee business expenses, investment expenses, tax preparation costs).

Here is another example where the tax cost of capital gains and qualified dividends is more than the advertised 0%, 15% or 20% maximum tax rate.

Long-term capital gains and qualified dividends are taxed separately at 0%, 15%, or 20% in the actual calculation of the AMT (page 2 of Form 6251) – but this income is included in AGI and therefore increases Alternative Minimum Taxable Income (AMTI).  The AMT exemption is reduced by 25% of the amount AMTI exceeds $153,900 for a married couple filing jointly.  So $10,000 of long-term capital gain could cost $2,150 and not $1,500– 21.5% and not 15% - or more because it reduces the AMT exemption, and increases the amount subject to AMT, by $2,500 ($10,000 x 25% - $2,500 x 26% = $650 + $1,500).

We are told that the AMT tax rates are 26% and 28%.  But for couples whose AMTI exceeds $153,900 (half of that for those filing separately and $115,400 for unmarried taxpayers) the effective tax rate on additional AMTI is actually 32.5% or 35% because of the reduction in the AMT exemption.  Additional income of $10,000 from any source other than capital gains or qualified dividends could cost $3,250 or $3,500 and not $2,600 or $2,800.

Of course the best solution to this problem is to do away with the dreaded AMT altogether in a complete rewrite of the Tax Code. 

TTFN

NINA OLSEN ON THE DREADED AMT

Here are excerpts from Nina Olsen’s 2012 Annual Report to Congress concerning the dreaded Alternative Minimum Tax (AMT).  I wholeheartedly agree with her recommendation!

“The Alternative Minimum Tax Corrodes Both the Tax System and the Democratic Process -

Problem

The individual Alternative Minimum Tax (AMT) was originally enacted to ensure wealthy persons paid at least some tax. Because the AMT is not indexed for inflation {it now is – rdf}, limited to high income taxpayers, or focused on tax loopholes, however, it increasingly penalizes middle income taxpayers for having children, getting married, or paying state and local taxes while allowing thousands of millionaires to pay no tax at all. The AMT is complicated and burdensome, even for those who are not subject to it. Many taxpayers must fill out the lengthy AMT form only to find they owe little or no AMT after all.

Analysis

The AMT requires taxpayers to compute their taxes twice — once under the regular tax rules and again under the AMT rules. If the ‘tentative’ AMT liability exceeds the regular tax liability, the taxpayer pays the difference as AMT. Thus, the AMT reduces the transparency of the tax system, making it more difficult for nearly everyone one to predict what they will owe.  

The AMT is difficult to repeal because it is projected to raise a large amount of revenue. However, AMT patches have always prevented the AMT from raising these projected amounts. In other words, we have a law that grants popular tax benefits (the regular tax code), another law (the AMT) that eliminates the benefits, and then another law that undoes the elimination of benefits (the patches), usually at the last minute — a legislative Rube Goldberg contraption of unnecessary complexity. In addition, the AMT reduces the transparency of the tax reform debate. For example, any revenue estimate for the proposal must be compared to the illusory revenue supposedly generated by expiration of the AMT patch under current law. Thus, the AMT corrodes the both the tax system and the democratic process.

Recommendation

Permanently repeal the AMT.”

TTFN

 

WTF IS THIS AMT EVERYONE IS TALKING ABOUT?

The dreaded Alternative Minimum Tax (AMT) is a strange animal.

Congress has passed a permanent AMT "patch" - indexing for inflation of the AMT exemption amounts.  While this is more better than no patch at all, the better action would be to get rid of the damned thing altogether as part of a total overhaul of the Tax Code.  But we must take what we can get. 

The dreaded AMT, which should more appropriately be called the Mandatory Maximum Tax, was originally enacted in 1969 in response to testimony by the Secretary of the Treasury that 155 individuals with Adjusted Gross Income of more than $200,000 (over $1 Million in today’s dollars) paid “0” tax on their 1967 tax returns. Congress received more letters that year on the Secretary’s testimony than they did on the Vietnam War!

Of course Congress being idiots, rather than responding by acting logically and eliminating the loopholes in the tax code that allowed the high income individuals to avoid paying tax the fools reacted and created a complicated alternative tax system.

The passive activity and other rules included in the Tax Reform Act of 1986 effectively closed many of the loopholes used by the wealthy to avoid taxes that had led to the creation of the dreaded AMT.  But instead of doing away with the AMT, as should have been done, the Act revised it into a kind of “stealth tax” to deceive the American public.

We were told that TRA 86 would reduce and, to a degree simplify, taxes for all – which it did under the “regular” income tax.  But what Washington gave with one hand via the regular tax they took back from the middle and upper middle class with the other hand via the dreaded AMT.

To be sure the current AMT does not affect the truly wealthy – the so-called 1%.  As I said, it takes its toll on the middle and upper middle class, especially penalizing families in highly taxed states.  

The calculation of the dreaded AMT begins with net taxable income on the 1040, before the deduction for exemptions, and adds back what are considered to be “tax preferences”.  All taxes and all miscellaneous deductions claimed on Schedule A are among these preferences, as is interest on home equity debt not used to buy, build, or improve a personal residence.  The Standard Deduction is also a preference, and is added back in determining Alternative Minimum Taxable Income (AMTI).  A special AMT exemption, based on filing status, is allowed.  This exemption is phased out as the AMTI increases.

The dreaded AMT is a flat 26%, increasing to 28% for income, after the exemption, above $175,000 (or $87,500 for Married Filing Separately).

While qualified dividends and long-term capital gains are taxed at reduced rates, both for regular tax and the dreaded AMT, this income is included in the calculation of AMTI, and therefore can reduce the allowable AMT exemption.

Under TRA 86 the AMT exemptions were not indexed for inflation.  These amounts were slightly increased by the Omnibus Budget Reconciliation Act of 1993, but again not indexed for inflation.  They were raised for tax years 2001 through 2004 by the Economic Growth and Tax Relief Reconciliation Act of 2001.  The Jobs and Growth Tax Relief Reconciliation Act of 2003 increased the exemption amounts again for 2003 and 2004, and these amounts were extended for 2005 by the Working Families Tax Relief Act of 2004.

What has become known as the “AMT patch”, the annual indexing of the exemptions for inflation, began with 2006.  However the “patch” was not made permanent, and has had to be extended each year, one year at a time (except when it was extended for 2 years in 2010), by the idiots in Congress. 

The last “patch” expired on December 31, 2011, and was not extended for 2012.

The Senate compromise bill permanently "fixes" the AMT beginning in 2011.  A better solution would be to do away completely with the dreaded AMT as part of a substantive overhaul of the convoluted Tax Code.

TTFN

A LAST MINUTE AGREEMENT

As I do each morning when I rise (except during the tax season), I have been checking Twitter for tax-related “tweets” that lead me to online sources of news and commentary.  This morning I was especially interested in finding details on the literally 11^th-hour Senate “fiscal cliff” agreement.

CNN MONEY tells us “Senate Bill Stops Many Tax Hikes, but Leaves Big Issues Pending”.  The bill would (highlights are mine) -

“Make most Bush tax cuts permanent: The Bush-era income tax rates would be permanently extended for all income up to $400,000 ($450,000 if married). Bush tax cuts that apply to income above those levels would expire.

Effectively that means for households above those thresholds, their top rate would rise to 39.6%, up from 35% in 2012.

Plus, the capital gains and dividend tax rates for these high-income households would increase to 20% from 15%. For everyone else, investment tax rates would remain at 15% or below {I assume permanently, and I assume the 0% rate remains – rdf}.

The compromise bill would also preserve the expanded parameters for the American Opportunity Tax Credit, the Child Tax Credit and Earned Income Tax Credit for 5 more years.

Permanently protect the middle class from the AMT: The bill would permanently adjust the income exemption levels for the Alternative Minimum Tax for inflation.

Cap itemized deductions on high-income households: The Biden-McConnell compromise would cap how much those making $250,000 (married couples making $300,000) may take in itemized deductions.

Retain several expired tax breaks for individuals: The compromise bill would extend for one or two years a few "temporary" tax breaks for individuals that regularly are extended. These include an option to deduct state and local sales taxes in place of state and local income taxes; and a deduction for elementary and secondary school teachers for certain expenses.

Permanently extend a more lenient estate tax: The legislation would preserve the current estate tax exemption level of $5.12 million but index it to inflation for future years. And it would raise the top rate to 40% from 35% currently.”

Any negotiated agreement made at the very last minute (literally) by idiots like the members of Congress is bound to be at the very least flawed, if not actually bad.

My concern is that in making the bulk of the provisions “permanent” will give the Administration an excuse to avoid tackling serious and substantive tax reform in 2013 (or through 2016) as had been hoped for (at least by me) – since there is no looming expiration deadline.

I guess a permanent AMT patch is better than annual one-year patches – but neither are better than doing away with the dreaded AMT altogether as part of an overhaul of the convoluted Tax Code.

There were some temporary aspects of the bill – the American Opportunity Credit, Child Tax Credit, and the Earned Income Credit, all with refundable components, for 5 years.  A clear sign that the Tax Code will continue to be improperly used as a vehicle to distribute social welfare benefits.  And the excessive tax fraud that results from refundble tax credits will continue for at least another 5 years.

The bill seems to bring back “Pease-like” limitations on itemized deductions for the “wealthy” (although these victims are less wealthy than those hit by the increased tax rate).  I am against any kind of cap or phase-out of itemized deductions in general, and would rather remove some of the actual deductions.

And the popular “extenders” have been extended for “one or two years”.  As long as the idiots were making things permanent what is wrong with these?

As I said in my previous post it ain’t over till it’s over.  I do not hear the fat lady warming up.  The big challenge to this agreement is the House, who will either accept, reject, or revise (most probably revise) the Senate bill.  And then there is the Conference Committee, and the beat goes on.   

On the 2013 withholding front ACCOUNTING TODAY reported this morning that -

“The Internal Revenue Service released new income tax withholding tables for 2013 late Monday to reflect the expiration of the 2001 and 2003 Bush tax cuts and the more recent payroll tax cuts of 2011 and 2012, but noted that the guidance would be modified if Congress acts.”

And -

“In issuing the guidance, the IRS said it takes note of the fact that Congress is currently considering legislation that could affect these rates. If the legislation is enacted, IRS will issue new, corresponding tables at that time.”

I had received an email from Intuit Payroll (Quickbooks) on Friday stating that it would continue the 2012 withholding tables into 2013 until Congress acts.  I trust software companies in general do the same and wait for the end of this negotiation before revising their programs, so as not to FU withholding.

TTFN