High income with 28% tax rate? that\'s the AMT Sweet Spot

1. Alternative Minimum Tax:
Theory and Examples
General Tax Planning Case Studies
Tom Davison, Wendy Trout

2. Wendy Trout, CFP®
Tom Davison, MA, PhD, CFP®
wendy@summitfin.com, tom@summitfin.com
Summit Financial Strategies, Inc
2 © Summit Financial Strategies, Inc 3/11/2009

3. Summit Financial Strategies, Inc.
Helping affluent families achieve financial stability and security
Our Ideal Client
Wealth Management Service
$1,000,000 of liquid Investments or $250,000 in
household income
Business owners with $3,000,000 net worth
Investment Management Service
$300,000 of liquid investment assets
401(k)s, IRAs, trusts, personal accounts
Fee-only Independent Fiduciary
3 © Summit Financial Strategies, Inc 3/11/2009

4. Alternative Minimum Tax
 Name is descriptive
 Alternative to the Regular Tax
 Wealthy pay at least a minimum
 1969
 Deep in Vietnam War, country needed more revenue
 Public outcry: in 1967 155 people with incomes over
$200,000 paid no tax; 20 were millionaires
 Tax “loopholes” to blame
 Simple tax
 Few deductions
 Almost a flat tax
 Difficult to avoid
4 © Summit Financial Strategies, Inc 3/11/2009

5. AMT structure
 More things count as income
 Two tax brackets:
 0 - $175,000 is 26%
 > $175,000 is 28%
 Almost a flat tax: How much did you make? Send the IRS
26%
 No personal exemptions
 No standard deduction
 Both personal exemptions standard deduction replaced
by larger AMT exemption
 Very few itemized deductions
 Capital gains taxed at same rate as Regular Tax
5 © Summit Financial Strategies, Inc 3/11/2009

6. General Method
 Parallel tax structure between Regular Tax and AMT
 Compute tax in Regular Tax
 Compute tax in Alternative Minimum Tax
 Pay the larger of the two
6 © Summit Financial Strategies, Inc 3/11/2009

7. $300,000 income, MFJ, 2 Kids, Ohio
Regular Tax
Income 300,000
Personal Exemptions 11,667
Charitable Deductions 5,000
State Tax 15,000
Local Tax 6,000
Property Tax 10,000
Mortgage Interest 10,000
Total Deductions 46,000
3% AGI Floor -1,401
Total Itemized deductions 44,599
Taxable Income 243,734
Regular Tax (RT) 59,161
7 © Summit Financial Strategies, Inc 3/11/2009

8. $300,000 income, MFJ, 2 Kids, Ohio
Regular Tax AMT AMT Tax Structure
Income 300,000 300,000
Personal Exemptions 11,667 - No personal exemptions
Charitable Deductions 5,000 5,000
State Tax 15,000 - Tax-related deductions don't
Local Tax 6,000 - count
Property Tax 10,000 -
Mortgage Interest 10,000 10,000 Mortgage and charity do count
Total Deductions 46,000
3% AGI Floor -1,401
Total Itemized deductions 44,599 15,000 Much smaller deductions
Taxable Income 243,734
Regular Tax (RT) 59,161
Alt Min Taxable Income (AMTI) 285,000 300,000 - 15,000
AMT Exemption 36,200
Taxable Amount 248,800
Tentative Minimum Tax (TMT) 66,164 TMT > RT
Alternative Minimum Tax (AMT) 7,003 Additional tax paid
8 © Summit Financial Strategies, Inc 2/3/2009

9. Regular Tax AMT AMT Tax Structure
Income 300,000 300,000 More income counts
Personal Exemptions 11,667 - No personal exemptions
Charitable Deductions 5,000 5,000 Fewer deductions allowed
State Tax 15,000 - Tax-related deductions don't count
Local Tax 6,000 -
Property Tax 10,000 -
Mortgage Interest 10,000 10,000 Mortgage and charity do count
Total 46,000
3% AGI Floor -1,401 Deductions not reduced for AGI
Total Itemized 44,599 15,000
Standard Deduction 11,900 No standard deduction
Total Deductions 56,499
Taxable Income 243,734
Regular Tax 59,161
Alt Min Taxable Income (AMTI) 285,000 300,000 - 15,000
Exemption replaces Personal Exemption and Standard
AMT Exemption 69,950 Deduction
Exemption is phased out by 25% of every dollar over
Less phaseout -33,750 $150,000 of AMTI. (285,000 - 150,000)*.25 = 33750
AMT Exemption after phaseout 36,200
Taxable Amount 248,800
Tentative Minimum Tax 66,164 (175000)*0.26 = 45,500
(248,800-175,000)*0.28 = 20,664
Alternative Minimum Tax (AMT) 7,003 66,164-59,161
9 © Summit Financial Strategies, Inc 3/11/2009

10. AMT is not inflation indexed
 The 1967 $200,000 taxpayer’s income would be
about $1.3 Million now
 AMT Bracket definitions
 0 - $175,000 at 26%
 $175,000 and over at 28%
 AMT Personal Exemptions
Tax Code 2011 patch
Married Filing Joint $45,000 $74,450
Single $33,750 $48,450
 Regular tax: brackets, standard deduction,
exemptions are all indexed for inflation
10 © Summit Financial Strategies, Inc 3/11/2009

11. Income differences between AMT & RT
 Municipal bond income from Private Activity Bonds
 Bonds for private activities – e.g., a hotel
 Incentive Stock Options
 Exercise an option to buy your company stock
 E.g., you can buy $50 stock for $10
 In regular tax, that’s $40 of income
 In AMT, that can be $0 of income in certain cases
 AMT expects to have higher future capital gain tax, but total tax
bite expected to be lower than Regular Tax
11 © Summit Financial Strategies, Inc 3/11/2009

12. Deduction differences - highlights
 No personal exemptions
 No standard deduction
 AMT Medical over 10% of AGI, rather than 7.5% of
AGI
 AMT Home equity loan interest not deductible unless
used to improve or acquire home. RT: non-acquisition
debt deductible up to $100,000
 Taxes are not deductible: State, local, and real estate
taxes
 Miscellaneous itemized deductions are not deductible
 Investment advisory fees are miscellaneous itemized
deductions
12 © Summit Financial Strategies, Inc 3/11/2009
 Depreciation – can’t use various accelerated

13. Calculation method
 Appears more complicated than how we’ve
presented it
 Language is off-putting
 Starts with Taxable Income from regular tax
calculations, and then does “add-backs”
 Preference items: can only increase AMTI (AMT
Taxable Income)
 Adjustment items: can increase or decrease AMTI
 Form 6251 and 8801
13 © Summit Financial Strategies, Inc 3/11/2009

14. Common Tax Planning Strategies
 Tax brackets
 Maximize use of lower brackets
 Accelerate income, defer deductions
 Avoid higher brackets
 Defer income; accelerate deductions
 Qualify for deductions or credits
 First time homebuyer credit
 Credits more important than deductions (100% vs. fractions)
 Watch for thresholds that must be exceeded
 Bunching to get over threshold
 Itemized deductions > Standard deductions
 Medical deductions > 7.5% of AGI
 Watch for phaseouts
 Anticipate next year – Multiyear savings often most valuable
14 © Summit Financial Strategies, Inc 3/11/2009

15. AMT Sweet Spot: High income, but 28% marginal bracket
AMT above AMT Exemption Phaseout but below 35% Regular Tax
RT at 35%
AMT and Regular Tax
AMT at 28%: Sweet Spot
Top of Sweet Spot:
Deductions at 35%,
Income taxed at 28%
Married Filing Jointly
AMT at 35% in AGI ~$400K to
Exemption Phaseout ~$600K+
AMT at 28% Regular tax grows at 35%
Adjusted Gross Income

16. AMT Sweet Spot: High income, but 28% marginal bracket
AMT above AMT Exemption Phaseout but below 35% Regular Tax
RT at 35%
AMT and Regular Tax
AMT at 28%: Sweet Spot
Top of Sweet Spot:
Deductions at 35%,
Income taxed at 28%
Married Filing Jointly
AMT at 35% in AGI ~$400K to
Exemption Phaseout ~$600K+
AMT at 28% Regular tax grows at 35%
Adjusted Gross Income

17. AMT Sweet Spot: High income, but 28% marginal bracket
AMT above AMT Exemption Phaseout but below 35% Regular Tax
RT at 35%
AMT and Regular Tax
AMT at 28%: Sweet Spot
Top of Sweet Spot:
Deductions at 35%,
Income taxed at 28%
Married Filing Jointly
AMT at 35% in AGI ~$400K to
Exemption Phaseout ~$600K+
AMT at 28% Regular tax grows at 35%
Adjusted Gross Income

18. Sweet spot: AMT and Regular Tax for High Incomes
 2011 AMT Exemption is $74,450
 Starts to phase out at $150,000 of AMT taxable income
 Phaseout: for every $1.00 of income, lose $0.25 of exemption.
Takes 4*$74,450 of income to completely phase the exemption
out
 Exemption completely phased out: $74,450*4 + $150,000 =
$447,800
 At $447,800 of income:
 Just below, effective marginal AMT rate is 28% * 1.25, or 35%
 Just above, the effective marginal AMT tax rate is 28%
 Marginal rate stays 28% until regular tax is larger than AMT:
perhaps $600,000 of income
 Exact point when RT is larger than AMT depends on individual’s
whole tax picture, in both RT and AMT
18 © Summit Financial Strategies, Inc 3/11/2009

19. How to use the sweet spot?
 In it, have high income person, at only 28% tax bracket
Increase income:
 Contribute to Roth 401(k) rather than regular 401(k) – pay tax
now
 Don’t do deferred compensation
 Exercise stock options
 Recognize capital gains
 2010 – do Roth conversion
 Above it, now at 35% income, and in Regular Tax. Expected
to be in AMT 28% sweet spot next year
 Make sure state tax fully paid during calendar year – don’t wait
until April 15th
 Prepay real estate tax
 Bunch charitable deductions (use donor advised fund to do
several year’s worth of charitable deductions)
 We’ve saved clients $25,000 in taxes over a two year period.

20. General Tax Planning Steps
 Do taxes without additional action
 Add $1000 of income, see how much tax bill changes. See the
effective marginal rate
 Understand why the rate doesn’t match the tax table
 Where does income fall in tax tables?
 Add & subtract $10,000 of income. Marginal rate change?
 Near a change in marginal rate?
 Just over or under a phaseout range?
 Just over or under qualifying for a credit?
 Project tax situation for following year(s)
 Especially near transitions
 AMT and Regular Tax
 How close are Regular Tax and AMT?
 The goal is not a big refund. If anything, it is to owe $$ on April
15th
20 © Summit Financial Strategies, Inc 3/11/2009