The alternative minimum tax.

• Author: Karlinsky, Stewart S.

Ever since Congress enacted the alternative minimum tax (AMT) system in the Tax Reform Act of 1986 (TRA), taxpayers have become painfully aware that planning for the AMT is crucial. This planning has not always been easy, since Congress and the IRS have continuously added, redefined and even tried to simplify the AMT. This article will discuss AMT current developments, including recent proposed and final regulations, court cases and the impact of the Revenue Reconciliation Act of 1993 (RRA). It will also discuss several IRS letter rulings related to the AMT. While letter rulings apply only to the taxpayer who requested them, they often provide valuable insight into the Service's interpretation of the law, and tax practitioners can cite them as substantial authority.(1) (1)Regs. Sec. 1.6662-4(d)(3)(iii).

RRA AMT Changes

* AMT rate changes

While the RRA left the corporate AMT rate at 20%, it changed the individual rate from a flat 24% tax to a progressive tax, beginning in 1993. Individual taxpayers must now calculate their 1993 AMT at a 26% rate for the first $175,000 of alternative minimum taxable income (AMTI) above the AMT exemption, and at a 28% rate for amounts over that.(2) (2)RRA Section 13203(a) amending Sec. 55(b)(1).

Because the maximum rates for AMT and capital gains for individuals are the same, taxpayers with large amounts of capital gains and relatively little ordinary income in 1993 may be surprised to find themselves having to pay AMT. This new rate parity accentuates the effect of other preferences and adjustments. For example, a single payer with $400,000 of long-term capital gain income and $53,500 of ordinary income after a deduction of $40,000 for state income taxes and other itemized deductions will owe over $10,000 in AMT ($124, 107 regular tax versus $134,680 AMT).

* New trust rates

The RRA dramatically increased the regular tax rates for trusts and estates. Trusts now face a regular tax rate of 36% for taxable income over $5,500 and 39.6% for taxable income over $7,500.(3) Taxpayers who in the past have used trusts as a vehicle to spread AMT adjustments and preferences among several taxpaying entities may find this strategy significantly less beneficial. (3)RRA Section 13201(a) adding Sec. 1(e).

* AMT exemption amount changes

While the RRA kept the corporate AMT exemption amount at $40,000, beginning in 1993 the individual exemption amounts have been increased to $45,000 for married taxpayers filing jointly and to $33,750 for single taxpayers.(4) These exemption benefits are phased out at certain levels of AMTI. For example, married taxpayers filing jointly lose some of their AMT exemption between $150,000 and $330,000; once these taxpayers reach $330,000 of AMTI, the AMT exemption is totally phased out. (4)RRA Section 13203(b) amending Sec. 55(d)(1) and (2).

* No retroactive tax hike reprieve

Congress took some of the pain out of the new higher regular tax rates for individuals, but those who have a higher 1993 AMT liability will not be so lucky. Taxpayers may elect to pay the amount of their 1993 tax increase due to the new higher regular tax brackets in three equal interest-free installments, but they may not delay any increases attributable to higher AMT rates.(5) (5)RRA Conference Committee Report, Act Section 13201(d).

Example 1: H has a 1993 regular tax liability of $220,000, an AMT tax liability of $160,000, and would have had a $140,000 regular tax liability under the old rates. H will be able to spread $60,000 ($220,000 - $160,000) of her $80,000 regular tax increase over three years. Three $20,000 payments would be due on April 15 of 1994, 1995 and 1996.

* Repeal of charitable contribution perference

The RRA repealed the AMT preference for charitable contributions of appreciated property. This relief applies to contributions of tangible personal property made after June 30, 1992 and to contributions of all property made after Dec. 31, 1992. Property contributed in past years retains the treatment applicable to the contribution in the year contributed.(6) Thus, a charitable contribution carryover related to real property or stock donated during 1992, which would be deductible in 1993 or a future year, will still be subject to the AMT preference.

(6)RRA Section 13171(a) repealing Sec. 57(a)(6) and Section 13171(b) adding Sec. 56(g)(4)(J).

* AMT investment interest expense

Beginning in 1993, the RRA has limited a tax planning tool for individual taxpayers who might otherwise include net long-term capital gains from the disposition of investment property in their investment interest expense limitation calculation.(7) Taxpayers may make a special election to include these gains in their limitation calculation, but each dollar they include must be excluded from the 28% maximum AMT rate and taxed at ordinary income rates. Thus, while some high-income taxpayers may no longer want to sell appreciated stock or property to free up investment interest expense deductions for regular tax purposes, Congress did not address whether such capital gains could be included in a taxpayer's net investment income calculation for AMT purposes. Since no special maximum capital gains rate for AMT exists, capital gains do not receive favorable treatment in the parallel AMT calculations. Thus, taxpayers should be able to include these capital gains in their AMT investment interest expense calculation without necessarily making the election for regular tax.(8) This may allow the taxpayer a larger Sec. 163(d) deduction for AMT than for regular tax. In effect, the taxpayer would make an election under Sec. 163(d)(4)(B) for AMT, but not for regular tax.(9)

(7)Sec. 163(d)(4)(B), amended by RRA Section 13206(d).

(8)Temp. Regs. Sec. 1.163(d)-1T, issued on 12/23/93, simply states that the capital gains affected by the election to include amounts in investment income "are not eligible for the maximum capital gains rate of 28%."

(9)Elections are made on the Form 4952, Investment Interest Expense Deduction, and can apparently be made by filing two forms, one for regular tax and one for AMT.

* Impact of itemized deduction changes on AMT

Beginning in 1994, when individuals lose the "below the line" deductibility of club dues, certain lobbying expenses and 50% of meals and entertainment deductions, their regular taxable incomes will be closer to their AMTI.(10) Also, since certain tax preparation fees,(11) moving expenses and a portion...