Both taxpayers' administrative burden and taxable earnings are practical and are affected by an election of a particular depreciation system. The goal should probably be to reduce the administrative burden from the planning standpoint of the closest held corporation.
It is crucial to know that many corporations have limited clerical and administrative personnel. Some of these corporations need to reduce costs due to an electing depreciation method that reduces by maintaining less AMT depreciation.
Wealthy taxpayers can be stopped from using other strategies and deductions to remove their tax through the alternative minimum tax benefits. It is like an alternative tax system that can stick people with a higher tax bill than they would have paid for regular income tax. When figuring out a person's AMT depreciation methods, they would sometimes have to recalculate some deductions such as depreciation adjustments.
The Birth of Alternative Minimum Tax
Something interesting happened in 1968 when Congress ,which consisted of 155 taxpayers earning more than $200,000, paid no income tax. These people increased existing tax deductions and had to be careful about how they earned income, thereby whittling their tax debt down legally.
Congress created the alternative minimum tax after fielding a flurry of complaints from outraged taxpayers. Companies recalculated their income tax under the alternative minimum tax with many deductions taken out.
Nothing changes if someone's income falls under the AMT exemption threshold. If a person's income is higher and the AMT depreciation on it is more than their regular tax depreciation total, they pay the added AMT amount.
It affects many taxpayers who are not equivalent to millionaires because, for years, the AMT, unlike tax brackets, didn't adapt for inflation. Recent tax law changes change the alternative minimum tax rules, so it should have much more impact on the wealthy than the middle class in the future. These changes mean C corporations are exempt from paying AMT.
What Income Bracket Does Alternative Minimum Tax Begin?
One of the essential questions about AMT is, 'When is alternative minimum tax instilled on an account?" The exemption amount changes regularly because Congress eventually indexed AMT depreciation for inflation.
Note that in 2020 the following AMT depreciation statistics were recorded:
If married or filing separately, the cutoff is $55,850
Income of $71,700 or less is exempt if you are a single taxpayer or going as a head of household
If a person is married, filing jointing, a qualified widow or widower, the cutoff is $111,700
Income below the exemption amount isn't subject to the alternative minimum tax. If someone makes the above cutoff, the person can be exempt from some of the income tax from AMT depreciation. Above a certain amount, the cost begins to shrink and stood close to $56,000 for single filers in early 2021.
IRS Form 6251
People can calculate alternative minimum tax on IRS Form 6251. Near the top of the form, the person can enter their taxable earnings from their 1040 on line 11b. Then they can adjust that amount to various factors. Say, for example, the individual reported a net operating loss deduction on their tax-exempt interest; they have to add it back to their taxable income.
In order to make things more complex, some entries have to be calculated differently from people with their regular income tax. In most cases, a person cannot always transfer the figures over from their 1040 ad-related schedules.
After making all the AMT adjustments, people should subtract the AMT exemption from their alternative taxable income. They can also calculate the tax on the remaining amount. If it's more than their regular income tax, they will have to pay extra each month.
Alternative Minimum Tax Example
Suppose someone runs their S corporation like a business and vice versa is a tremendous alternative minimum tax example. Unlike a C corporation, the company pays no tax, the income passes through the person, and they pay income tax, so AMT depreciation adjustment applies.
The person's income report on their 1040 is $62,000, and they are a single filer. Suppose someone runs it through the AMT number-crunching process and ends with $70,000 - that is excellent. Their income falls under the exempt amount, so they don't have to pay any AMT depreciation adjustment fee.
When a person adjusts their $62,000 income and ends up with $75,500, they would subtract the $71,700 exemption amount from their income, leaving $3,800. If someone is a single filer, they will multiply this by 0.28 getting $1,064.
The next step is to subtract the more significant figure from the above amount, and it would display a negative number, essentially meaning the individual doesn't have to pay any tax.
Suppose someone's income after adjustment is $147,000, which leaves them with $75,300 in non-exempt income. The individual would multiply this amount by 0.28, then remove the $3,896 to end with $17,188 in tax. If that is, say, more than $5,000 than someone's regular income tax, they add the extra $5,100 to their tax bill.
There are nearly 25 income adjustments listed on Form 6251, including income from long-term contracts, mining costs, stock options, exercise, passive losses, and alternative minimum tax depreciation adjustment costs.
The process may not be too tedious if the individual does not have a lot of adjustments to perform. It is essential to be aware that there is no convenient alternative minimum tax calculator to punch these numbers into.
Why Would Someone Have to Pay AMT Depreciation Adjustment?
The simple way to explain why someone would have to pay AMT or see how close they came to paying it is by checking out their Form 6251 from the previous year.
Look for entries on lines 2 and 3, which adjust the taxable income for AMT depreciation adjustment purposes. An instance of this is someone has to put various items back into their income, adding such items as their standard deduction, taxes deductions on Schedule A, the bargain element of any incentive stock options they exercised, and several investment-related items.
Compare the Tentative Minimum Tax to their regular tax (Tentative Minimum Tax should be the line above the person's regular tax) to see how close they were to pay the AMT depreciation adjustment.
Business Taxable Income and AMT
Under 2018's big tax cut bill, the C corporations of America got a great deal. Corporate income was subject to an alternative minimum tax but significantly more up until that point. If someone's business is a C corporation, the alternative minimum tax is one tax problem they no longer have to worry about.
Other business structures include limited liability companies, partnerships, and sole proprietorships designed to pass business income to the company owners. The business owner reports their share of income as personal income, which becomes subject to the top alternative minimum tax.
If this person claimed AMT adjustment on their 1040, whether, through personal right or business expense, they must deal with the AMT depreciation adjustment.
In order to make things even more fun, the individual doesn't have to deal with alternative minimum tax depreciation in just one place on Form 6251. AMT depreciation adjustment has several separate categories; which have been listed below:
Depreciation on assets placed in service after 1986 goes on line L
Alternative minimum tax return depreciation related to profit or loss from a partnership or S corporation goes on line 2N; a certain amount and limitations apply
If someone uses farm activity as a tax shelter, related deprecations deductions are included on line 3
Business activities in which a person has no amount of risk covered are also on line 2N
Depreciation deductions related to passive activities have to be accounted for in the passive activities entry on line 2M
Alternative Minimum Tax AMT Depreciation Adjustment: The Exemptions
The IRS has a detailed list of instructions for alternative minimum tax depreciation, including multiple types of depreciation that most people don't have to recalculate. Below are some of the properties that AMT is not an issue for:
Natural gas pipelines placed in service after 2005
Movies, videotapes, or sounds recordings
Some Native American reservation property
Residential rental property depreciated by any method not measured in years
Suppose someone took a Section 179 expense property as their business property exempt from the alternative minimum tax. Section 179 allows someone to write off the cost of some assets as an expense rather than putting them through AMT adjustments. If they only write off part of the cost, the rest of the AMT depreciation adjustment will be managed over time
Residential rental property is eligible for a special depreciation provided the depreciable basis is the same for both AMT depreciating assets and income tax. This includes subsidies for disaster assistance property, recycling property, some biofuel plants, some opportunity zone property, and some other disaster or recovery assistance property. If an individual does not apply for a special allowance and the residential rental property was placed in service before 2016, it is not exempt
Other property placed in service after 1998 depreciated with straight-line methods or using the 150% declining balance method
A Section 1250 property was placed in service after 1998 and depreciated with the straight-line method. These section 1250 methods include various real estate types so that business owners can use them
Residential rental property for which someone used the alternative depreciation adjustment system (ADS)
Nine residential real estates were placed in service after 1998. Provided these locations had a depreciation period of 27.5 years and the owner uses the straight-line method to deduct it
Residential rental property that someone placed in service after 1998
Recalculating Depreciation for Alternative Minimum Tax
There is more than one method of calculating income tax depreciation, and there is more than a single method to understand alternative minimum tax depreciation. It is essential to know that there are three methods for AMT depreciation, which include the following:
The 150% decline balance method over the class life; if there is a point at which straight-line depreciation gives a more significant deduction, people can switch to their approach
Straight-line depreciation takes over the assets alternative minimum tax class life different property as assigned to agent classes for AMT calculations, each with its own time frame
A straight line 40 years depreciation adjustment
It is spelled out in the IRS instructions which method a person should use; the asset class life is also determined by the regulations set out by the Internal Revenue Service after 1998. If people need information on the subject, they can look under IRS publication 946, covering depreciation.
Figuring Out AMT Depreciation
Calculating the effect of AMT description for line L on the form can be relatively easy despite all the depreciation methods and classes. Using the appropriate method for the desired assets, calculate the alternative minimum tax depreciation. All people need to do is subtract this from their regular income tax depreciation and enter the result.
Suppose someone wants an alternative tax example. Assume the person can pay $800 in fair market value depreciation on some of their business assets, meaning the write-off is subject to AMT adjustment. When a person runs things through the appropriate AMT depreciation method, depreciation is kept to a minimum of $450. Then, report the $250 difference on line L.
If someone's AMT depreciation turns out to be $900, they should follow the same method of subtracting it from their income tax depreciation. In this case, they would enter -$100 on line L.
How to Benefit from the AMT System
The provision of Sec 168 (b)(2)(d) for property eligible for the MACRS (modified accelerated cost recovery system) means that no depreciation adjustment is necessary for (AMT) alternative minimum tax purposes.
This modified accelerated cost recovery system can be used with a 168(b)(2)(D) for asking the election to use alternative minimum tax depreciation for both AMT purposes and regular tax return reasons.
In addition, the regular MACRS recovery periods can be used for alternative minimum tax purposes or as a regulator. Resident rental property or MACRS 39-year real property does not need an election to avoid two computations for a MACRS 27.5 year real property.
People can use the straight-line method for AMT depreciation purposes and MACRS, and the recovery periods are similar. The same fixed asset record for AMT and regular tax will be part of the AMT 150% DB method. However, a separate set of adjusted current earning depreciation records will still be maintained for property placed in service before 1994. In the case of property placed in service after 1998, class lives must be used for both alternative minimum tax and regular tax purposes.
Moreover, if the election is made only for the property established after 1998, separate AMT depreciation details will still need to be maintained for property placed in service before 1999.
There are no longer requirements for ACE purposes (Sec. 60)(g)(4)(4) to make another depreciation computation for a property placed in service after 1993.
If the choice is made to sue the AMT depreciation system for AMT credit purposes and regular tax purposes, the election could be made on the days in which the property is subject to a difference of two taxes.
The elections must be made each year for the property placed in service during that year. Each election is made by completing Form 4562 Depreciation and Amortization and returning the documents with an Internal Revenue Code.
How to Benefit from the ADS System
A property placed in service after 1986 for which the ADS (Alternative Depreciation System) usually does not require depreciation adjustment for AMT purposes. The straight line or ADS will allow the same set of fixed asset records for regular tax, profit purposes, ACE, AMT, and tax year earnings.
However, while the class life is generally more extended than those depreciation deductions prescribed by MACRS, any given year is likely to be lower if the AMT depreciation method or another method is elected.
Special Depreciation Cases
There are slightly different treatments for other types of AMT depreciations displayed on the other lines of Form 6251. An example of this is if someone has a passive activity loss that includes $800 depreciation, they don't get to write to $800 on the AMT, and instead, they reduce their loss by that amount and then regulate the loss using AMT rules.
If a person is invested in a partnership or S corporation but has no money at risk, they report any losses on Line N of Form 6251. Then they can recalculate any related AMT depreciation as part of the total loss using alternative minimum tax rules. It is crucial to enter the difference between the AMT loss and the income tax amount on Line N. If someone has a property that they depreciate according to the pre-1987 rules; they must report the depreciation on Line 3 after getting the figures. This is also where they will require tax write-offs from farming or mining costs.
Reporting the Adjustment
AMT depreciation is only one of the factors a person's business may have to consider when working out alternative minimum tax. By the end of the number crunching, people have to have one figure for their total added AMT tax.
You may want to enter the amount on the first line of Schedule 2. If the amount is negative, enter zero. Schedule 2 is for value-added taxes such as alternative minimum tax, household employment tax, and self-employment tax. People need to take the Schedule 2 comprehensive report on their 1040 and add the amount to their tax bill and taxable IRA distributions.
If a person wants to know in advance if they should set extra money aside for AMT, they could look at their prior-year minimum tax on Form 6251. Once someone has the figures, they can make any changes or adjustments; it is crucial to see if any depreciation of any assets was claimed for the first time this year. When a person understands how things add up, they will probably have a better idea if the AMTs will bite hard or not at all.
Reducing the Number of AMT Depreciation Adjustments
The example below discusses the uses of various depreciation methods to reduce the complexity and number of AMT depreciation adjustments.
Example
X corporation was formed on September 1, 2008, and filed its first tax return for the two months ending in December 2008. In Jan 2009, this same company purchased $50,000 of assets in each of the traditional MACRS personal residential rental property asset classes (seven years, five years, and three-year courses.)
During its first tax year (2008), X corporation would be exempt from the AMT. Assets that do not meet the small business corporation gross receipts test are subject to the AMT in the following years. Remember that the adjustment for excessive depreciation works only for a property placed in service after the change.
The change date is the first day of the tax year that the taxpayer ceases to meet the small business computation exemption. This results in X having to include an adjustment for excess depreciation on property established after 2008.
This property was placed in service in January 2009 and qualified for the Sec 168 (k) bonus depreciation. X can claim bonus depreciation and or Sec 179 expenses on these assets without creating an AMT depreciation adjustment.
Suppose X elects not to take the Sec 179 deduction of the amount of property placed in service exceeding the Sec 179 limitation; X will need to decide whether to use AMT depreciation for AMT or regular tax purposes. If the company elects to use the AMT method, there will be no AMT tax adjustment for excessive depreciation because the AMT depreciation and regular tax amounts will be the same. The only thing is the onset of fixed asset depreciation records will need to be maintained.
How Can Someone Escape the AMT?
One of the best things that can be said about the AMT is that Congress successfully made it challenging to get around this tax. In order to avoid the AMT, a person needs to understand how the AMT differs from the regular tax system. Walk through Form 6251, line by line, to see how the AMT handles different deductions and expenses. Where there is a tax planning opportunity, a professional can suggest how to lessen the impact of the AMT.
Taxable Income
A person's taxable income is displayed on line 11b of their 1040. AGI (adjustable gross income); is their taxable income minus itemized or standard deductions and qualified business income.
Deductible Taxes or Standard Deduction from Schedule A
In calculating the AMT, a person cannot take itemized deductions for state and local income tax, real estate taxes, and personal property taxes, even though these are deductible on their regular return.
Suggestion one: An individual has to pay the AMT in a year, they shouldn't bother prepaying real estate or fourth-quarter state estimated tax payments in December. This person gets no benefit from paying these taxes in a year that they are subject to the AMT.
Suggestion two: Personal property taxes and real estate are not removable for AMT if they are part of itemized deductions. Taxes payable by a company schedule, farm schedule (Schedule F or Form 4835), (Schedule C), and rental schedule (Schedule E), are allowed for the AMT.
Perhaps someone qualifies for a home office, which would allow them to deduct part of their home real estate tax on Schedule C
If a person has a farm operation and uses their vehicle for work, they might be able to deduct the personal property tax on the car on Schedule F
Suppose people have vacant land on which they pay real estate taxes, they could turn it into a farm rental and deduct the taxes on Form 4835.
Investment interest
The investment standard deduction may differ for AMT purposes because it's decided if someone has a private activity bond interest (see line 12). If the person does, they may have an additional deduction for investment interest.
Depletion
People can calculate depletion from oil, timber, gas, mining, or other similar activities using either the percentage of cost depletion method for regular tax purposes. Concerning AMT, only the cost method is allowed.
Business credits
Because of the AMT, people may not be receiving all of their tax credits, such as the Low-Income Housing or Work Opportunity Credits.
Someone's Tentative Minimum Tax limits these credits and most general business credits other than the energy credit, and these credits cannot reduce the person's tax below the Tentative Minimum Tax.
If the individual has any of these credits, usually from a business entity or an investment, they may want to analyze Line 2 of Form 6251 to see how to reduce their Tentative Minimum Tax and allow more credits.
Any general business credit not allowed generally may be carried back two years and moved forward 20 years.
How Can Someone Plan Ahead for the AMT?
There are some things people can do to plan for the Alternative Minimum Tax:
Use tax-planning software during the year to minimize overall tax liability.
Study Form 6251 each time to prepare tax returns to see how close they are to paying the AMT. Evaluate how close the Tentative Minimum Tax was to the person's regular tax.
Check last year's return for any general business credits carried forward. Some may be due to the Tentative Minimum Tax limit, if there are some.
If someone exercises stock options during the year, see Incentive Stock Options above for guidance on how the timing of the subsequent sale of stock can affect AMT liability.
Conclusion
Regular tax and Alternative Minimum Tax are challenging things to master. With the help of a professional finance manager, software, or an accountant, people can make sense of this tricky tax incorporated by the United States government. Ultimately, it would be best to hire a wealth advisor in Pittsburgh. They can also help those who would like to know more about and apply the retirement bucket strategy.
*This material was prepared for The Kelley Financial Group.
*This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. The Kelley Financial Group, Stratos Wealth Partners, and LPL Financial do not offer tax advice or services.