Finance Tax Time

Does your incorporated business pay alternative minimum tax [”AMT]? If so, there is a 93% chance you have been overpaying your taxes by an average of $11,000 a year according to the Treasury Inspector General.

The Office of the Treasury Inspector General for Tax Administration was created in 1999 to oversee the IRS. One of the duties of the Treasury Inspector General is to study and report the efficiency of the tax payment system, particularly the accuracy of tax collection efforts. Many of the studies conducted by the office reveal starting results, particularly when it comes to businesses overpaying their taxes.

As part of this oversight, the Treasury Inspector General is reporting that many small business corporations are incorrectly paying AMT. The AMT was enacted in the late 1990s, but proved to be a huge burden on small businesses. The tax was confusing and the paperwork was incredibly complex. An amendment was subsequently added to give small business corporations relief from the AMT. Section 55(e) of the Internal Revenue Code now contains language exempting small business corporations from paying the AMT.

Small business corporations can claim an exemption from the AMT if gross revenues average $5 million or less for the initial three years of business. Thereafter, the business can continue to claim the exemption as long as revenues average $7.5 million or less of each subsequent three year period.

According to the Inspector General, companies that fail to claim an exemption to the AMT are overpaying taxes by an average of $11,638 each year. 93% of small business corporations qualify for the exemption. Since the IRS has no duty to notify taxpayers of overpayments, many small business corporations have no idea they are overpaying taxes and are due refunds.

All taxpayers have the right to file amended tax returns for the past three calendar years. Contact us now to find out if you failed to claim the exemption to the AMT and are due a refund for 2001, 2002 and 2003. If you failed to claim the AMT exemption, you may be due a refund totaling over $33,000.

Richard Chapo is CEO of http://www.businesstaxrecovery.com - Obtaining tax refunds for small businesses by finding overlooked tax deductions and credits through a free tax return review.

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More and more taxpayers are finding a hidden tax on their individual tax returns. This tax was originally designed to not allow taxpayer in the higher income brackets take advantage of tax driven policy like deducting:

• A lot of itemized deductions
• High local and state tax deductions
• Child exemptions
• A Mortgage deduction

Just to give you a sense of who might get caught. If your joint income is below $150,000 you are allowed a $58,000 AMT exemption. What that means is that you can safely deduct up to $58,000 of the deductions listed above without incurring the AMT tax However, once taxable income climbs above $150,000 the exemption is phased out by 25 cents for every dollar earned above that until finally at $382,000, there is no exemption at all. This year only 1.8 percent of married couples with two kids and an adjusted gross income between $75,000 and $100,000 will be subject to AMT. However, about 73% of the taxpayers earning income above $382,000 will experience AMT.

The following tax planning strategies should be reviewed to help individuals counter the AMT and plan successfully for their financial future:

1. Acceleration of Ordinary Income. Individuals who expect to owe should consider accelerating ordinary and short-term capital gain income and deferring into the next year. Possible deductions to defer include state and local income taxes, real estate taxes, and miscellaneous itemized deductions subject to the two percent floor, which are not deductible under the AMT system. This planning technique is contrary to typical advice, but it may lower the ultimate tax bill.
2. Acceleration of Expenses. Individuals who are not subject to the AMT in 2005, but who will be in 2006, should accelerate expenses that are not deductible for AMT purposes into 2005. Also, they should consider selling private activity bonds and or paying off home equity debt if the interest expense is not deductible for AMT purposes.
3. Blend Tax Rates between years. Some of the differences between the AMT and regular tax systems are merely matters of the timing when deductions are taken. For instance, the AMT generally requires slower depreciation than is permitted for regular tax purposes. Other differences are permanent; for example, state income taxes can never be deducted under the AMT system, while under the regular system, they are deductible when paid. Paying AMT in one year may generate a credit against a future year’s regular tax, particularly when adjustments are due to timing differences. Overall, an individual may be better off if AMT is paid in a previous year in order to gain a credit in a later year. Perform a multi-year analysis to anticipate the effect of planning techniques used in 2005 on future years.
4. Stock Option Exercises. Consider whether any exercised incentive stock options should be disqualified (a disqualified disposition) before year-end to minimize the AMT liability, especially if the stock has dropped in value.
5. Beware of the AMT Traps. Watch out for other AMT traps, such as income from private activity (municipal) bonds, which is taxable under the AMT. In addition, certain mortgage interest, such as from a home equity loan, is subject to AMT if the funds from the loan are not used to buy, build, or substantially improve a primary or second home.
6. Utilizing Lower Capital Gain Rates. Taking advantage of lower capital gains rates can produce AMT implications in several situations, so be careful to consider the overall tax situation before taking any action. For example, the bargain element associated with the exercise of an incentive stock option is subject to AMT. Similarly, any large capital gain may raise your state and local taxes to a level that would trigger AMT. The resulting AMT could wipe out some or all of the benefit expected from the lower capital gains rate. This makes it particularly important to plan on a multiyear basis for transactions that could trigger the AMT.
7. Perform an AMT self diagnosis. Falling victim to the AMT has many possible causes, but individuals may be particularly prone to AMT if any of the following issues exist: - Large state and local tax deductions - Large long-term capital gains - Large deductions for accelerated depreciation - Large miscellaneous itemized deductions - Mineral investments generating percentage depletion and intangible drilling costs - Research and development expenses - An exercise of incentive stock options - Tax-exempt income from private activity bonds.

If one or more of these conditions affects you, you should discuss your AMT situation with your tax adviser, as soon as possible. Planning now will help net savings today, and it will best position individuals for the future.

Alan L. Olsen is the managing partner at Greenstein, Rogoff, Olsen & Co., a top Bay Area CPA firm. He focuses on developing innovative strategies for business enterprises and individuals. A specialist in income tax planning, he frequently lectures and writes articles on tax issues for professional organizations and community groups. His website is ranked one of the top in the nation, featuring tax tools and business leadership articles: http://www.groco.com

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Do you think that Alternative Minimum Tax (AMT) is only for Incentive Stock Options (ISO) and the wealthy?

You may be subject to the Alternative Minimum Tax (AMT) in 2006, even if you have the same income and deductions as 2005. The current AMT tax rules sunset and return to pre-reform levels, meaning that millions of people will suddenly be subject to AMT next year.

The Alternative Minimum Tax (AMT) is a separate tax system, with its own rates and deduction rules, that sits side-by-side with the main income tax system. Taxpayers must figure their taxes both ways, and pay under whichever system results in the most taxes. AMT has a lower tax rate ( 26-28%), but allows less deductions. AMT was originally passed to keep the rich from avoiding taxes through creative (but legal) accounting however, because AMT rules were not indexed for inflation, every year more and more ordinary taxpayers are becoming subject to AMT.

Will This Affect Me? The Congressional Budget Office estimates that 16.7% of taxpayers with Adjusted Gross Incomes of $100,000 to $200,000 will pay AMT in tax year 2005. For the 2006 tax year, this percentages jumps to 81.1%. In other words, if you earn over $100,000 per year, you most likely will be subject to AMT in 2006, unless Congress changes the law.

What Can I Do to Avoid AMT in 2006? You may not be able to avoid AMT, but you can minimize its affects by taking any deductions in 2005 that would be wasted under the AMT system, in tax year 2006.

The most common deductions affected by AMT:

• no standard deduction
• no exemptions (e.g., children)
• no state, local, or property tax deduction
• no miscellaneous itemized deductions (e.g., tax preparer fees)
• no mortgage interest deduction if funds are not used to purchase,
  build, or improve home (e.g., to pay off credit cards, or purchase a car)
• medical expense deduction floor raised to 10% AGI (instead of 7.5%)
• Incentive Stock Option (ISO) taxed if exercised, even if not sold

Tips for end-of-year 2005, to avoid wasting deductions in 2006:

• prepay real estate taxes
• prepay miscellaneous itemize deduction items
• prepay state/local taxes (see tax preparer) by paying 4th
  quarter estimates in 2005, or using prepay voucher (if W-2 employee)
• prepay medical expenses
• use HELOC for home improvements, instead of other purchases
• defer income away from 2006 by fully funding retirement plans, IRAs,
  deferred compensation plans, and health savings accounts

* * please contact your tax preparer before making any tax planning decisions

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this newsletter was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Here are some other year-end tips you may find useful:

Elizabeth Potts Weinstein, JD, a licensed attorney and Registered Investment Advisor, is the founder of Potts Weinstein Financial Consulting, a financial and estate planning firm, headquartered in San Jose, California. The firm specializes in providing fee-only, hourly financial planning, estate planning, and investment advice for people from all walks of life and income brackets. For more information about Potts Weinstein Financial Consulting, or to subscribe to our monthly eZine ‘Prosper!’, please visit http://www.pottsweinstein.com.

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