Demystifying the Alternative Minimum Tax
Demystifying the Alternative Minimum Tax
(Originally appeared in Bottom Line, July 2000)
If you’re new in this business or just plain lucky, you might not be aware that there are actually TWO “sets” of tax code – one that applies to regular tax, and the other for Alternative Minimum Tax (AMT). No, this article will not attempt to teach what AMT is and how it works – that would take an entire series of Bottom Line articles just to scratch the surface. Instead, we’ll introduce a new tool in our arsenal to aid us in dealing with the complicated AMT adjustment and preference items. It’s the new IRS MSSP Audit Technique Guide for Individual Alternative Minimum Tax.
Audit Guides, in General.
If you’re not familiar with Audit Guides, these are detailed guides for IRS agents examining under its Market Segment Specialization Program. The guides are intended to help IRS examiners focus on significant issues unique to particular industries. They can also help us learn about the accounting and tax aspects of specific industries – crucial elements in marketing to and servicing small business clients. If you market to or have clients in the business of trucking, veterinary medicine, garden centers and equipment sales, greenhouses, nurseries and mulch companies, charter tours, taxi and limo services, or used car sales (just to name a few), you need to check out the Audit Guides.
In recent years, even topic-related Audit Guides, such as Passive Activity Losses and now, AMT, have been added to the mix. Many of the smaller Audit Guides are available free from the IRS web site, viewable with Adobe Acrobat, or directly online. The larger Audit Guides are available for sale by the Superintendent of Documents.
AMT in a Nutshell.
The regular tax laws give special treatment to some types of income, allow special deductions for some types of expenses, and allow credits for certain taxpayers. Taxpayers who are not required to pay tax under the regular tax system may still be liable for tax under the AMT laws. According to the IRS, these laws create an “equity” in the system, requiring higher income individuals with certain deductions to pay tax. Without the AMT laws, the IRS says that these individuals would pay little or no tax, while those with lower income levels and no deductions would pay higher tax. AMT is triggered when a taxpayer has enough preference items and adjustments.
The Individual AMT Audit Guide offers line-by-line guidance on how the alternative minimum tax for individuals is calculated on Form 6251, Alternative Minimum Tax – Individuals. It details a host of adjustments and preference items that figure into the computation. It walks readers through the adjustments and preference items taxpayers can claim on the Form 6251, provides guidance on determining alternative minimum taxable income, and offers a final section on the calculation of the AMT itself.
It’s interesting in itself that the IRS has developed this particular Audit Guide. Up to now, the general consensus was that IRS agents have been as much in the dark about AMT as we’ve been. Be forewarned that this might be changing! Could it be that in the advent of this Audit Guide, the IRS will now focus its efforts on AMT audits? AMT is becoming very commonplace for middle-income taxpayers, as the Home Office tax support team has seen through an upsurge of questions relating to AMT – especially for the Incentive Stock Option adjustment item. The IRS is obviously well aware of this, as we are now seeing the beginning of its efforts to prepare agents for AMT audits.
Focus on Adjustment and Preference Items.
Luckily for us, more than half the Audit Guide is devoted to helping the reader determine how various preferences and adjustments should be figured into the complex AMT calculation, offering some basic rules of thumb for approaching certain issues. The following example of the online version of the guide illustrates how the Audit Guide is set up; each underlined item representing a hyperlink to the detail explanation on that adjustment or preference line item.
…Chapter 2, Computing AMT
- Form 6251 Alternative Minimum Tax-Individuals
- Adjustments and Preference Items
- Line 1, Standard Deduction and Itemized Deductions
- Line 2, Medical and Dental Expenses
- Line 3, Taxes
- Line 4, Interest on Home Mortgage
- Line 5, Miscellaneous Itemized Deductions
- Line 6, Refund of Taxes
- Line 7, Investment Interest
- Line 8, Post-1986 Depreciation
- Line 9, Adjusted Gain or Loss
- Line 10, Incentive Stock Options…
The guide indicates that agents should focus carefully on taxpayers’ investment interest, particularly interest reported as tax-exempt on the Form 1040, since this is taxable for AMT. It also provides detailed instructions on calculating depreciation for AMT purposes for eight different classes of property. If depreciation is shown on a tax return, the guide instructs agents to ask for a detailed depreciation schedule for regular and AMT purposes. “If the taxpayer is claiming a depreciation deduction and no adjustment item is listed for AMT, there is a high probability that there should be an adjustment on Form 6251 for AMT,” the IRS said. The document also provides instructions for examining a wide range of other deductions, including incentive stock options, passive activity losses, inheritance amounts, tax-exempt interest from private activity bonds, and charitable deductions. The Audit Guide also covers the mechanics of calculating the AMT credit, available in future years on “deferral items”
If you’ve been ignoring AMT up to this point, wishing it would just go away, its time to reconsider your thinking! Begin with familiarizing yourself with the AMT-related acronyms: ATNOL, ATNOLD, AMTFTC, IDC, ADS, ISO…. And remember, as always, the Padgett tax support team is ready to help you beat the learning curve on understanding AMT!