AMT Explained

Want to understand the true essence of pain? Watch the face of a taxpayer who completes a tax return showing a $2,000 refund. Then remind him of the Alternative Minimum Tax (AMT), and tell him it results in a net $3,000 in additional taxes owed. This is what is happening to more and more middle class Americans. However, with a good idea of what you’re up against, you can plan for the AMT and, I hope, avoid it entirely

How does the AMT work? Well, Congress designed the AMT in 1969. It's supposed to ensure that everyone especially the most affluent pays at least some tax. The AMT mandates a recomputation of your federal taxable income at a flat tax of 26%, and you are required to pay the higher of two tax bills. It becomes a flat tax of 28% on AMT taxable income over $175,000 for all taxpayers except those who file "married filing separately." For these taxpayers the 28% rate applies to income above $87,5000. The rate is applied on your income after your standard or itemized deductions but before your personal exemptions. Now, here is where the pain starts, the amount (line 37 on your 1040) is then increased by what are called “tax preferences.” and is reduced by an exemption amount that phases out as your AMT taxable income increases.

“Tax preferences” are nothing more than tax benefits or deductions that Congress has decided to give you under the regular tax system and then take away from you under the AMT tax system. Here’s what I mean. If you took the standard deduction, forget it. It’s a tax preference. Did you itemize? Medical expenses are normally deductible to the extent they exceed 7.5% of your adjusted gross income under the regular tax system but not for the Alternative Minimum Tax system. Under the AMT computation, you can only deduct the excess over 10% of your adjusted gross income. Forget the deduction for state and local income taxes or property taxes. They’re all tax preferences, and are added back into your AMT income. Congratulations if you live in a high income-tax state like New York or pay substantial real estate or personal property taxes! So watch out if your state is talking about increasing property or state taxes to close budget gaps. Do you itemize? Kiss your miscellaneous itemized deductions goodbye. That means investment expenses, tax preparation costs, job hunting expenses and all non-reimbursed employee business expenses lose their tax benefits.

By the year 2010 and probably regardless of the Bush tax cuts, the number of taxpayers affected by the AMT will rise to as many as 17 million, or about one in six. The revenue gain for the Treasury: from $5.8 billion a year to $38.2 billion a year. The reason more of us will be affected by the AMT in 2010 than now is that the AMT, unlike normal tax brackets, isn’t indexed for inflation. If it were indexed, as much of the tax code is, the projected increase would only be to 2.1 million taxpayers. Among the taxpayers increasingly exposed will be those with large families because of exclusions of such items as child credits. So plan, plan, plan!

More Year End Planning Part 3

Make a charitable transfer: Individuals who are at least 70½ years old can also make a tax-free transfer from their IRA of up to $100,000 to a charity, as long as the transfer is direct to the organization. This can be useful for retirees who must take required minimum distributions from an IRA, but since the money goes untaxed, donors do not get to deduct the contribution.

Prepay bills: Prepaying things such as January's mortgage bill, a child's spring semester tuition, local property taxes or state income taxes and even tax-advisory and preparation fees can help drive up the amount of deductions you can itemize.

• Prepay Deductible Expenditures: Early payments for some deductible expenditures that are made this year -- instead of in early 2009 -- will produce higher write-offs for your 2008 tax return. This strategy makes sense if you expect to be in the same or lower tax bracket next year. Of course, that’s a big "if," but let’s assume it’s the case. Monthly mortgage payment Perhaps the easiest expense to prepay is your house payment due Jan. 1. By paying it this year, you'll have 13 months' worth of mortgage interest to write off for 2008. You can pull the same prepayment trick with a vacation home. By prepaying this year, you’ll have to continue the policy for next year and beyond. Otherwise, you’ll only have 11 months of interest to deduct for the first year you stop.

• State and local income and property taxes: Prepayment of state and local income and property taxes that aren't actually due until early next year can also generate a larger 2008 deduction. Thanks to a new tax-law provision, even non-itemizers can deduct real property taxes paid during 2008. However, the maximum write-off under the new rule is $1,000 for married joint-filing couples and $500 for others and the deduction cannot exceed the amount you actually pay by year's end. Do not do these prepayment drills if you know you’ll owe the dreaded alternative minimum tax (AMT) for this year. Write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying these expenses will do little or no tax-saving good for AMT victims.

• Medical expenses and itemized deductions: Also, consider prepaying expenses that are subject to limits based on your adjusted gross income (AGI). The two prime candidates are unreimbursed medical expenses and miscellaneous itemized deductions. Medical expenses are deductible only to the extent they exceed 7.5% of AGI. Miscellaneous deductions for investment expenses, tax preparation fees, tax advice, and unreimbursed employee business expenses are deductable to the extent they exceed 2% of AGI. If you can combine these expenditures into a single calendar year, you’ll have a fighting chance of clearing the AGI hurdles and getting some write-offs. Unfortunately, this strategy may not work for AMT victims. Under the AMT rules, medical expenses must exceed 10% of AGI to be deductible and miscellaneous itemized deductions are completely disallowed.

• Prepay College Tuition: If your 2008 adjusted gross income (AGI) allows you to qualify for the Hope Scholarship or the Lifetime Learning higher education tax credits, consider prepaying college tuition bills for 2009 if that would result in a bigger credit on this year’s 1040 form. Specifically, you can claim a 2008 credit based on prepaying tuition for academic periods that begin in January through March of next year. If your 2008 AGI is too high to be eligible for the Hope or Lifetime credits, you might still be able to deduct up to $2,000 or $4,000 of college tuition costs. If so, consider prepaying tuition bills for academic periods that begin in the first three months of 2009 if that would result in a bigger write-off on this year’s Form
  
  

Business expenses: Smaller items also add up, so restocking work-related supplies, renewing subscriptions to professional journals or prepaying dues for professional organizations can also help reduce taxes.

Medical expenses: Review your medical bills to see whether the total spent is close to 7.5 percent of adjusted gross income. If your expenses are at or near that threshold, it might make sense to have other elective work done or prepay some expenses to take advantage of that deduction.

Make a gift: The law also allows taxpayers to deduct gifts of up to $12,000, or $24,000 for a married couple filing a joint return. What's more, there's no cap on gift deductions for educational and medical expenses if the payments are made directly to the educational organization or medical provider.

Think alternative energy or hybrid: Finally, there are tax credits available for several energy-saving investments, including installing alternative energy devices such as solar panels, fuel cells or wind turbines to provide electricity for a home, and for buying alternative fuel vehicles. There are tax credits available for the purchase of a hybrid or electric car. A list of the credits available for different models is available on the Internal Revenue Service Web site, http://www.irs.gov/.

More Year End Planning Part 2

I always view Thanksgiving as a time for family getting together and being thankful for all of our blessings, and the start of the Christmas season when spending money on gifts becomes a priority. It is also a good time to do some end of the year tax planning so that we don't get any surprises when we file our tax returns.

Get organized: The first step in the planning process is to make sure your records are organized and up to date. Without records and without substantiating your deductions, you have no deductions.

Defer income into the new year: If you are scheduled to receive a bonus ask to receive it in January so that the additional income is not included in your 2008 AGI. For the self-employed, sending invoices out late in December could make it more likely you'll receive payment in the new year.

Check on capital gains and losses: It's important to find out whether you might have capital gains to report. A lot of mutual funds have been forced to sell assets as investors bailed out of the market. So despite the fact that the fund probably posted losses, investors might be receiving a capital gains distribution. In addition, you might want to consider selling some holdings that have lost value as the market tanked to offset any capital gains. Current law allows investors to claim up to $3,000 in short term capital losses.

Determine whether you're subject to AMT: The Alternative Minimum Tax, which was designed to make sure that high-income earners with multiple deductions pay at least some tax, now captures many upper middle-class workers because it is not indexed to inflation. So if you live in a state such as New York this is something you should be concerned about. Congress included a measure to adjust the AMT so that most people are exempt in the bailout bill, but figuring out whether you need to pay can still be a complicated task that might require help from a tax adviser.

Boost your charitable deductions: Any check written or item donated before Dec. 31 can be deducted. So if you haven't done this yet, clean out your closets and donate those old suits, dresses and other items that you aren't wearing any more as well as any furniture to charity. Since many organizations are also feeling pinched by the economic downturn. If you don't have much credit card debt, you can charge a donation before the end of the year and pay it off in 2009.

2009 Standard Mileage Rates

The Internal Revenue Service has issued the 2009 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.

Beginning on Jan. 1, 2009, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:

• 55 cents per mile for business miles driven
• 24 cents per mile driven for medical or moving purposes
• 14 cents per mile driven in service of charitable organizations

The new rates for business, medical and moving purposes are slightly lower than rates for the second half of 2008 that were raised by a special adjustment mid-year in response to a spike in gasoline prices. The rate for charitable purposes is set by law and is unchanged from 2008.

The business mileage rate was 50.5 cents in the first half of 2008 and 58.5 cents in the second half. The medical and moving rate was 19 cents in the first half and 27 cents in the second half.
The mileage rates for 2009 reflect generally higher transportation costs compared to a year ago, but the rates also factor in the recent reversal of rising gasoline prices. While gasoline is a significant factor in the mileage rate, other fixed and variable costs, such as depreciation, enter the calculation.

A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for any vehicle used for hire or for more than four vehicles used simultaneously.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

IRS Increases Dollar Amounts On Tax Provisions

While President-elect Obama modifies his initial tax plans as a result of the current economic crisis, the Internal Revenue service has by law revised various dollar amounts on various tax provisions in order to keep pace with inflation. These revisions include the personal and dependency exemption, the standard deduction, the earned income credit, and the annual gift exclusion.

• The value of each personal and dependency exemption, available to most taxpayers, is $3,650, up $150 from 2008.
  
• The new standard deduction is $11,400 for married couples filing a joint return (up $500), $5,700 for singles and married individuals filing separately (up $250) and $8,350 for heads of household (up $350). Nearly two out of three taxpayers take the standard deduction, rather than itemizing deductions, such as mortgage interest, charitable contributions and state and local taxes.
  
• Tax-bracket thresholds increase for each filing status. For a married couple filing a joint return, for example, the taxable-income threshold separating the 15-percent bracket from the 25-percent bracket is $67,900, up from $65,100 in 2008.
  
• The maximum earned income tax credit for low and moderate income workers and working families with two or more children is $5,028, up from $4,824. The income limit for the credit for joint return filers with two or more children is $43,415, up from $41,646.
  


• The annual gift exclusion rises to $13,000, up from $12,000 in 2008.

Some Year End Tax Planning

1. Book a tax-planning meeting in order to devise a year end strategy specifically for your firm. Why the need for fine-tuning? Some small companies' revenues are down for 2008, not because their business has declined but because pinched customers are paying their bills more slowly. As a result, additional revenue will trickle in as late payments during early 2009 just when tax rates may go. Some companies may have the equivalent of 10 months of income this year, and 14 next year and they may not want to defer additional income into 2009.

2. Take advantage of bonus depreciation.
For qualified assets placed in service in 2008, you may claim an extra 50% deduction in addition to normal depreciation and deductions available under the Internal Revenue Code's Section 179. The Section 179 "expensing" deduction allows a business to write off the full cost (rather than depreciating it over several years) of certain business assets, including machinery, vehicles, equipment, and computers, up to a certain dollar level. For 2008, the maximum deduction limit was increased to $250,000. The asset must be "placed in service" in 2008 in order to take advantage of the increased dollar limit for assets that will be expensed under section 179. Therefore, you cannot deduct the cost of a computer system you've ordered but that won't be operating in your office until January. "If you need a piece of equipment, make the purchase and get it placed in service in the same year.

3. If you have a vehicle that you use both for work and business, increase your business driving and decrease your personal driving to get the most out of the tax deduction for personally owned vehicles. If you use your vehicle for 50% business driving and 50% personal driving, try increasing your business driving in order to increase the allowale percentage of vehicle expenses as well as other vehicle expenses, like oil changes and maintenance.

Alternatively, you can choose to take the standard mileage rate for 2008. That was 50.5¢ per mile for the first half of 2008 and 58.5¢ per mile for the second half. Only small business owners that file Schedule Cs, such as sole proprietors, are allowed to choose which way to take their vehicle deductions.

4. If your company operates on the accrual basis for tax purposes, fix your employees' bonus amounts before Jan. 1, but pay them early next year. Generally, the bonuses aren't taxable to employees until 2009, but they can be deducted on your company's 2008 return so long as they're announced in 2008 and paid by Mar. 16, 2009.

5. If you're doing major renovations at your business location, make sure you schedule repairs and maintenance jobs separately. "Capital improvements aren't deductible as business expenses, however, ordinary and neccessary maintenance repairs are. Improvement costs are added to the 'basis' of the property for tax purposes." Lumping all the work into one project could cheat you out of 100% deductible business expenses.

6. Keep detailed records of collection efforts that will support any deductions you take for bad debt that becomes worthless in 2008. If you can't get one of those pinched clients to pay up, you can write the amount off provided you can show you made a good-faith effort to collect the debt. That means keeping records of telephone calls, letters, and other efforts you've made to get the money, including hiring a collection agency.

IRS Is Looking For Taxpayers Who Haven't Received Their Stimulus Checks And Refund Checks

The Internal Revenue Service is looking for taxpayers who are missing more than 279,000 economic stimulus checks totaling about $163 million and more than 104,000 regular refund checks totaling about $103 million that were returned by the U.S. Postal Service due to mailing address errors.

It is crucial that taxpayers who may be due a stimulus check update their addresses with the IRS by Nov. 28, 2008. By law, economic stimulus checks must be sent out by Dec. 31 of this year. The undeliverable economic stimulus checks average $583. The regular refund checks that were returned to the IRS average $988.

All a taxpayer has to do is update his or her address once. The IRS will then send out all checks due. The Where’s My Stimulus Payment? tool on the IRS Web site is the quickest and easiest way for a taxpayer to check the status of a stimulus check and receive instructions on how to update his or her address. Taxpayers can update their addresses with the Where’s My Refund? tool on the IRS Web site. It enables taxpayers to check the status of their refunds. A taxpayer must submit his or her social security number, filing status and amount of refund shown on their 2007 return. The tool will provide the status of their refund and in some cases provide instructions on how to resolve delivery problems

In order to avoid these problems in the future, the IRS encourages taxpayers to choose direct deposit when filing their returns. Direct deposit eliminates lost, stolen or undeliverable checks because it refund checks can be deposited directly into either a checking or savings account.