CHAPTER 28
Alternative Minimum Tax
- Alternative Minimum Tax Basics
- Deduction Limits for Alternative Minimum Tax
- Credit Offsets
- Minimum Tax Credit
Reducing regular tax is only part of the battle that a small business owner wages to increase after-tax returns. Minimizing or avoiding alternative minimum tax (AMT) where applicable is another important front that must be addressed. Some business owners may find themselves subject to AMT if they have certain substantial deductions and/or credits.
Alternative Minimum Tax Basics
Alternative minimum tax is designed to ensure that all taxpayers pay at least some tax. Years ago, with tax shelters and other loopholes, wealthy individuals and corporations often paid little or no tax. In an effort to make all taxpayers share the tax burden, an AMT was imposed.
The AMT is a separate tax system, with its own deductions and tax rates. A taxpayer computes the regular income tax as well as a tentative AMT. The extent to which the tentative AMT exceeds regular tax liability is reported as AMT.
Alternative minimum tax liability for individuals can be reduced by certain personal tax credits, including a limited foreign tax credit (corporations can reduce their AMT liability only by a limited foreign tax credit). There are 2 different AMT structures: one for C corporations and another for individuals.
C corporations pay AMT at the rate of 20%. This rate is applied to alternative minimum taxable income (AMTI) reduced by an exemption amount of $40,000 (reduced by 25% of the amount by which AMTI exceeds $150,000). Alternative minimum taxable income includes an adjusted current earnings (ACE) adjustment. This adjustment is designed to measure income tax on as broad a basis as it is for financial reporting purposes.
Individuals have a two-tier AMT rate structure of 26% on the first $186,300 of income subject to AMT in 2016 (called alternative minimum taxable income or AMTI), plus 28% on any excess amount. For married persons filing separately, the 26% rate applies to AMTI up to $93,150. The amount subject to these tax rates is reduced by an exemption amount. This exemption amount is phased out for high-income taxpayers.
The AMT exemption amounts for 2016 are:
$53,900 for single (unmarried) individuals
$83,800 for married persons filing jointly and surviving spouses
$41,900 for married persons filing separately
The exemption for individuals phases out when AMTI exceeds a threshold amount that depends on your filing status. For 2016, the thresholds are:
- $119,700 for single (unmarried)
- $159,700 for married persons filing jointly and surviving spouses
- $79,850 for married persons filing separately
Fortunately, AMT liability can be offset by nonrefundable personal credits.
Who is subject to the AMT? Potentially all businesses are subject to AMT. However, small C corporations may be exempt, as explained later in this chapter. Owners of pass-through entities (partnerships, LLCs, and S corporations) figure AMT on their individual returns. They include business items passed through to them and identified as AMT items on their Schedule K-1.
Exemption for Small Corporations
Small corporations are entirely exempt from AMT.
New C corporations (those with the first tax year being 2016), other than those aggregated with other corporations, are exempt from AMT in 2016 without regard to gross receipts. The tax law simply assumes that start-ups are small corporations.
Once your business is established as a small corporation, it retains that status (and is exempt from AMT) as long as its average gross receipts for the prior 3-year period do not exceed $7.5 million. The first year of small corporation status is ignored for purposes of this 3-year period.
Loss of Small Corporation Status
If your business succeeds to the extent that it loses its small corporation status, special AMT rules continue to apply to formerly small corporations. These rules simplify AMT for such corporations. In general, these corporations start fresh for certain AMT items and never have to make certain AMT adjustments.
Deduction Limits for Alternative Minimum Tax
Certain deductions that were allowed for regular tax purposes may be disallowed or modified for AMT. The following deductions that were claimed on individual returns may not be deducted for AMT purposes:
Personal exemptions
Any addition to the standard deduction
Itemized deduction for taxes
Itemized deduction for miscellaneous expenses
The following deductions that were claimed on individual returns must be modified for AMT purposes:
Investment interest.
Itemized deduction for medical expenses (only expenses in excess of 10% of adjusted gross income are deductible for AMT purposes, by all taxpayers without regard to age even though a 7.5%-of-AGI threshold applies to those age 65 and older for regular tax purposes for 2016).
Itemized deduction for home mortgage interest (only interest to buy, build, or substantially improve a principal residence or second home is deductible for AMT purposes, while interest on home equity loans used for other purposes may be deductible for regular tax purposes).
Depreciation.
Net operating losses (NOLs).
Mining exploration and development costs (the regular tax deduction must be amortized over 10 years).
Research and experimentation expenditures (costs must be amortized over 10 years if you are not a material participant in the business).
Passive activity losses from nonfarming activities (losses are adjusted for items not deductible for AMT purposes).
Adjustments For Depreciation
The depreciation method that you use for regular tax purposes may require that an adjustment be made for AMT purposes. For AMT purposes you are allowed only a limited depreciation deduction. If you claimed more for regular tax purposes, you must adjust your AMT income accordingly.
For property (other than real property) acquired after 1986, your AMT depreciation is limited to the 150% declining balance method, switching to straight line when a larger depreciation deduction results. For real property acquired after 1986, your AMT depreciation is limited to straight line over 40 years.
For real property placed in service after December 31, 1998, an AMT adjustment is no longer required. For personal property placed in service after this date, a depreciation election can be made to use the same depreciation method for regular and AMT purposes so that an AMT adjustment is avoided. By making this election, depreciation is figured using the 150% declining balance method over the regular tax recovery period (instead of the 200% declining balance method). For an explanation of these depreciation methods, see Chapter 14.
Preference Items
Certain items that may have escaped the regular tax are subject to AMT. These include:
Tax-exempt interest on private activity bonds issued after August 7, 1986.
Exclusion of 50% of the gain on the sale of small business stock (see Chapter 5).
Oil and gas preferences.
Accelerated depreciation on real property acquired before 1987.
Net Operating Losses
The NOL deduction for regular tax purposes must be adjusted for AMT. This is because only a limited NOL deduction is allowed for AMT purposes. The NOL for AMT purposes is the regular tax NOL except that the nonbusiness deduction adjustment includes only AMT itemized deductions (i.e., state and local taxes and certain other deductions cannot be used to figure the NOL deduction).
You may be able to eliminate your AMT liability because of your NOL deduction. However, the NOL deduction cannot be more than 90% of AMT income (without regard to the NOL deduction). If you cannot use all of your NOL because of the 90% limit, you may carry it back and forward under the applicable carryback/carryforward periods (explained in Chapter 4). However, the carryback and carryforward NOLs are also subject to the 90% limit.
Other Adjustments and Preferences
In figuring AMT income on which AMT tax is imposed, certain income items are also given special treatment. These include incentive stock options, long-term contracts, tax-exempt interest on private activity bonds, and basis adjustments for AMT gain or loss.
For C corporations other than small C corporations, the key adjustment that can trigger AMT is the ACE adjustment. However, since small corporations are exempt from AMT, this adjustment is not explained further.
Credit Offsets
Only certain tax credits can be used to offset AMT liability. Components of the general business credit cannot be used to offset this tax. In 2015, the credits that can offset AMT liability include:
Foreign tax credit.
Certain personal tax credits. Nonrefundable personal credits can be used to offset the AMT.
Effective for 2016 and beyond, owners of pass-through entities can use their share of a business's research credit as an offset to their personal AMT.
Minimum Tax Credit
If you paid AMT last year, you may be eligible for a tax credit this year. Different minimum tax credits apply for individuals and corporations.
Individuals
You qualify for a minimum tax credit if you meet any of the following 3 conditions:
You paid any AMT in 2015.
You had an unused minimum tax credit that you carried forward from 2015 to 2016.
You had certain unallowed business-related credits in 2015.
The credit is the amount of AMT paid in 2015 reduced by the part of the tax related to exclusion items (standard deduction, medical expenses, taxes, miscellaneous itemized deductions, gains on small business stock, tax-exempt interest from private activity bonds, and depletion). The credit may be increased by minimum tax credit carryforwards, and unallowed credits for nonconventional-source fuel, and orphan drugs.
Compute the credit on Form 8801. If the credit exceeds your AMT liability for 2015, the excess amount may be carried forward and used to offset AMT liability in a future year. There is no limit on the carryforward period.
Corporations
Unlike an individual's minimum tax credit which is limited to exclusion items, corporations that paid AMT in a prior year may claim a tax credit in 2016 if they have no AMT liability this year. Compute the credit on Form 8827, Credit for Prior Year Minimum Tax—Corporations.
Of course, since small corporations are exempt from AMT, only large corporations can have a minimum tax credit.
Self-Employed
If you have any adjustments or preference items, you must complete Form 6251, Alternative Minimum Tax—Individuals. You may or may not have any AMT liability. You can use a special AMT Assistant from the IRS at www.irs.gov / Businesses /Small-Businesses-&-Self-Employed/Alternative-Minimum-Tax-(AMT)-Assistant-for-Individuals to see immediately whether you will owe any AMT. The entries are anonymous and the results instantaneous.
Partnerships and LLCs
The business reports an owner's share of AMT items on Schedule K-1. As an owner, you must complete Form 6251 to see if you owe any AMT.
S Corporations
The business reports an owner's share of AMT items on Schedule K-1. As an owner, you must complete Form 6251 to see if you owe any AMT.
C Corporations
Small C corporations exempt from AMT are not required to complete any special forms. Other C corporations figure their AMT liability on Form 4626, Alternative Minimum Tax—Corporations.