Archive for the ‘AMT’ Tag
Back to Basics Part XXV – Form 8582 – Passive Activity Loss Limitations
Filed under: Back to Basics | Tags: active participation, AMT, earned income, Form 8582, material participation, Passive Activity Loss Limitations, passive income, portfolio income, real estate professionals, rental real estate, Section 469, suspended losses, Tax Reform Act of 1986, tax shelter
Leave a comment Originally published in the Cedar Street Times
October 16, 2015
Prior to the Tax Reform Act of 1986, both the nation and Congress were gripped with the ideas that the rich were not paying any taxes and that the tax code was overly complex. Sound familiar? The Tax Reform Act of 1986 was heralded as the biggest change to the income tax system since World War II. It did have sweeping changes and drastic effects. In the nearly 30 years since its enactment, all kinds of new exceptions and complexities have entered the code. That said, there are still a lot of landmark changes that affect our tax system today. One of these is in the area of passive losses.
Prior to 1986, wealthy individuals could invest in tax shelters which combined borrowed money and depreciation expense, while taking advantage of tax subsidies and tax preferences on certain types of investments to push out massive losses well in advance of their current, real economic investment and loss. Some of the tax subsidies and preferences were true reductions in tax, and the tax deferral parts of these plans essentially created interest-free loans from the government. The losses would then be used to offset income generating activities from wages, profitable business activities, and portfolio activities, virtually eliminating income tax for a lot of wealthy people. Tax shelters were popping up faster than Starbucks coffee houses, and draining capital which could have otherwise been invested in productive activities in America. There was also a lot of legal and accounting brain power being siphoned off to tax shelter creation.
The Tax Reform Act of 1986 (among many other things) setup three buckets for income, 1) earned income – such as from working for someone else or running a business yourself, 2) portfolio income – such as interest, dividends and capital gains from the sale of stocks, bonds, mutual funds, etc., and 3) passive income – such as investments in rental real estate properties and ownership interests of businesses in which you do not really work. The basic tenant, is that the three buckets are generally kept separate, and in order to deduct losses in one bucket, you have to have offsetting income in that same bucket, otherwise the losses get suspended to be used at a future time. Prior to 1986, there was just one bucket – income. After this three bucket concept was introduced, most of these tax shelters became useless. For some that managed to survive in other ways, another arm of the Tax Reform of Act of 1986 had to be reckoned with – Alternative Minimum Tax (I discussed AMT in a prior article which is posted on my website at www.tlongcpa.com/blog).
The passive activity rules are laid out in Section 469 of the Internal Revenue Code. There are a lot of rules in Section 469, but the short of it is that you usually need to work at least 500 hours a year in a business you own to be considered a material participant and keep the income or losses in the earned income bucket. So, if you own part of a business, but do not materially participate, any losses will be stuck in the passive activity bucket and get suspended until you have some passive activity income to offset, or until you liquidate your interest in the business.
For rental real estate activities, you generally have to spend 750 hours a year and have no other activity in which you spend more than 750 hours to throw the income or losses in the earned income bucket. People meeting this rule are considered “real estate professionals.” Rental real estate losses are a huge issue for California rental property owners, since massive losses accrue in the early years due to high mortgage interest and depreciation stemming from high purchase prices. Real estate professionals are allowed to deduct all their losses from rental properties against their other earned income. All other people are limited to using 0-$25,000 of losses per year against earned income depending on their modified adjusted gross income and whether or not they “actively participate.” Active participation is a pretty easy standard to meet. If you make managerial decisions, you are an active participant, and are eligible for the special $25,000 loss deduction. (The act of simply choosing a property manager to handle everything for you is a managerial decision, for instance.) If your modified adjusted gross income is over $125,000, however, the $25,000 active participation loss deduction starts to phase out. By the time you reach $150,000, it is gone.
All of this bring us to the point of today’s article – the Form 8582 – Passive Activity Loss Limitations. The Form 8582 is simply the vehicle used to track the activities in the passive income bucket and show which ones have suspended losses from year to year. The form is three pages long. The first page is the summary, and the second two pages are the detailed worksheets supporting page one. Rental real estate activities are separated on the form from all other passive activities, since they have the special $25,000 active participation rule that must be applied. Part I summarizes the items within those two categories and further breaks them down into activities with income, activities with losses, and prior year losses that have been suspended. You then net everything within each of the two categories. The rental real estate category then runs through Part II to see if you qualify for all or a portion of the special $25,000 loss allowance against earned income. Part III deals with Commercial Revitalization Deductions, which are just a favorable twist on the $25,000 rule for people who are rehabilitating certain buildings in distressed communities. Part IV sums the total losses that are allowed for the year.
The next two pages are the details for each business activity or rental property you own. This is where you would look to see how much suspended losses you may have on each property. Although you might not like the idea of having your losses limited each year, you will certainly enjoy the benefits down the road when you sell a property or business for a gain, and all those suspended passive losses come to your rescue! And it is also nice to know that if you sell one property for a large gain and the losses freed up from that particular property are not enough to offset its gain, then the suspended losses from all other properties are drawn from on a pro-rata basis until exhausted to help offset the gain as well.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part XXII – Form 6251 – AMT
Filed under: Back to Basics | Tags: 6251, adjustment, Alternative Minimum Tax, Alternative Minimum Taxable Income, AMT, AMT patch, AMTI, depreciation, employee business expenses, ESPP, home equity debt, investment advisory fees, ISO, itemized deductions, minimum tax credit, mortgage interest, parallel, preference, real estate taxes, standard deduction, state taxes, Tentative Minimum Tax
Leave a comment Originally published in the Cedar Street Times
September 4, 2015
AMT, or “Alternative Minimum Tax” was enacted in 1969 in response to a disturbing report by the Secretary of the Treasury that 155 taxpayers with adjusted gross incomes over $200,000 paid zero tax on their 1967 tax returns.
In its simplest form, AMT is a separate taxation system with its own set of rules that runs parallel to the regular tax system. You are supposed to run the calculations under both systems, and if the AMT system says you owe more tax than the regular system, then you pay the incremental difference as “AMT.” That incremental difference shows up as additional tax on Line 45 (2014) of your Form 1040. The calculation of AMT is summarized on Form 6251 and accompanying worksheets, as well as AMT versions of traditional schedules.
The irony of the AMT system is that most of the loopholes it was originally designed to prevent, no longer exist, and it has become a tax that affects the middle and upper-middle class more than the wealthy, yet we still have it and all of its complications. Today, those who are subject to it, despise its existence, and not many people fully understand it, tax practitioners included.
For people still preparing returns by hand, AMT is an absolute nightmare since many of your other schedules have to be calculated a second time using AMT rules. For instance, depreciation rules differ between the AMT system and the regular system, as accelerated depreciation methods are generally not allowed. This means you have to keep an entirely separate set of depreciation schedules just for AMT. And to make matters more complicated, California does not conform to all of the Federal AMT rules either. So now you end up with four sets of depreciation schedules – Federal regular, CA regular, Federal AMT, and CA AMT.
I do not think I have ever seen a hand-prepared return done correctly when AMT is involved. (Actually, in the last ten years, I do not think I have seen any hand-prepared returns done correctly!)
So when do you hit AMT? It depends. AMT is calculated on taxable income under about $185,000 at a flat 26 percent rate, and income over that mark at 28 percent. There is a $53,600-$83,400 AMT exemption amount depending on filing status.
Compared to the regular system, the standard deduction is thrown out (meaning itemizing is your only option), your normal exemptions for yourself, spouse and dependents get the boot, as do many itemized deductions such as state taxes, real estate taxes, mortgage interest on home equity debt (if the funds were not used to improve your home), unreimbursed employee business expenses, tax preparation fees, investment advisory fees and more.
As mentioned before, depreciation methods are not as generous, also ISOs and ESPPs have less tax-friendly rules, investment interest can be hacked, and a whole bunch of other specific differences that apply to certain situations.
Since some people will have more AMT adjustments and preferences than other people, there is no set dollar threshold that will trigger AMT. That said, I feel that I rarely see it for a Married Filing Joint return with under $100,000 of adjusted gross income. It also starts phasing out for people with high incomes. The top AMT rate is 28 percent, but has fewer deductions than the regular system. Besides a handful of lower brackets, the regular system also has 33, 35 and 39.6 percent brackets, but with more deductions. At some point, however, the higher tax rates outweigh the additional deductions and the regular system results in more tax than the AMT system. You may pay no AMT once you get to $600,000 or $700,000 of income, depending on your AMT adjustments.
People in AMT that are employees often feel trapped, especially those in the sales industry that are used to generating a lot of deductions from vehicle mileage and other expenses their employers do not reimburse. It does not matter how many unreimbursed expenses they come up with, they will all get thrown out in the AMT system.
For people that flip back and forth between years of AMT and no AMT, there can be a minimum tax credit generated by the AMT you paid that can be helpful. If you paid AMT in one year, and the next year the regular tax system is higher than the AMT system, you can get a credit against your regular tax to the extent of the difference between the two tax systems limited to the credit amount generated by certain deferral type AMT adjustments/preferences. Got it? Just trust me, sometimes it can help! There are also sometimes when flipping can be a negative…fairness is not always the result of our tax system.
The best news we have had about AMT in recent years was that in 2013 Congress finally legislated an annual inflation adjustment for the AMT exemption. For years Congress was in a habit of passing an AMT patch in late December or January to make up for the fact that the exemption was not inflation adjusted, and would return to 1993 levels if nothing was done.
Tax professionals were biting their nails some years wondering if it would happen. The impacts on middle class Americans would have been tremendous, and many were oblivious. I read estimates in 2011 that 4 million taxpayers were subject to the AMT, but without a patch that number would have swelled to 31 million! I can remember running scenarios for a family making around $100,000 and realizing they would have a surprise tax bill of an additional $2,000 or so without a patch.
The form itself is only two pages. Part I is a summary of all the adjustments and preferences that differ from the regular tax system, to arrive at Alternative Minimum Taxable Income (AMTI). Part II deals with calculating your AMT exemption, your Tentative Minimum Tax (tax calculation under the AMT system), and then the AMT itself (the amount your Tentative Minimum Tax exceeds the regular tax system amount). Part III is a supplemental calculation that feeds into Part II when your return includes capital gains, qualified dividends, or the foreign earned income exclusion.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back to Basics Part I – Overview of 1040
Filed under: Back to Basics | Tags: 1040, above the line, adjusted gross income, adjustments to income, Alternative Minimum Tax, AMT, basics, below the line, charitable contributions, childcare credit, credits, direct deposit, educator expenses, energy efficient upgrades, exemptions, filing status, first-time home buyer credit, health savings account contributions, Household employees, interest, itemized deductions, medical expenses, miscellaneous itemized deductions, moving expenses, other taxes, paid preparer, real estate taxes, retirement plan contributions, self-employment taxes, student loan interest, tax return, taxes, tuition and fees, understanding
Leave a comment Originally published in the Cedar Street Times
October 17, 2014
On Wednesday October 15, the 2013 personal tax filing season came to a close. Or at least it did for most timely filers. People who requested the six-month extension finally had to lay down their cards, or face increased penalties, and being branded delinquent by the taxing authorities. But I am sure you had your returns done long ago!
It is hard to believe that 2014 is rapidly drawing to a close, and soon we will start filing taxes all over again. This coming year, I would like to challenge you to spend some time looking at your tax returns and learning something new. I am a firm believer that everyone should have at least a basic understanding of the flow of a tax return. This document is a linchpin in your financial life. Let’s spend a few minutes talking about the big picture. You may wish to do this with a copy of a 1040 close at hand.
Tax returns can be hundreds of pages long with many supporting forms and schedules, but it all boils down to a two page summary whether you are John Doe or Warren Buffett…this is your Form 1040. Essentially, the first page lists your income, adjusted by a few preferential items leaving you with your all important “adjusted gross income.” “Below the line,” as it is known, is the second page, and lists your deductions and credits, calculates your tax, and determines what you owe or will get refunded.
Looking at page one in more detail, the top section captures your name, mailing address, and Social Security number. There is also a somewhat passe little box to designate three dollars of the tax you are already paying to the Presidential Election Campaign fund. If you want to learn more about this, I wrote an entire article on its history on April 18th. You can find it at www.tlongcpa.com/blog.
The first real section is where you designate your tax return “filing status” – single, married, head of household, etc. This is very important because it determines how much your standard deduction is and how quickly you will climb the tax brackets as your income increases. Your status is determined by rules, not choice. That said, married people do have the choice of the generally unfavorable Married Filing Separate status.
The next section deals with “exemptions.” This is where you list the dependents in your household – generally your children up through college (even if away at college). A parent or someone not even related can qualify, but they have to meet strict limiting rules. You get an exemption from your taxable income of $3,950 (2014 amount) for each of your dependents. Children under 17 may also qualify you for child tax credits which would go on page two.
The income section falls next. Wages from your job, interest, dividends, business income, rental income, sales of stock, money received from retirement accounts or plans, pensions, social security, etc.
After getting your total income figure, you then are allowed certain favorable “above the line” deductions for things like educator expenses, moving expenses, retirement plan contributions, health savings account contributions, student loan interest, tuition and fees, etc. After subtracting these adjustments, you arrive at your AGI (adjusted gross income). AGI is a key figure and is used in a lot of calculations which could affect your taxes in many areas. Above the line deductions are therefore preferable for that reason, but also because they will have a direct impact on taxable income. Below the line deductions such as itemized deductions are less certain and do not impact your AGI.
The taxes and credits section is at the top of the second page. This is where you get to subtract all your itemized deductions listed on Schedule A- things like medical expenses, taxes paid, interest, charitable contributions, and miscellaneous other deductions (like tax preparation fees!). If you don’t have many itemized deductions you get the standard deduction instead (for example – $12,200 for married status) as determined by your filing status from the first page.
Next, the number of exemptions you claimed on the first page is multiplied by $3,950 (2014) and that is subtracted out to leave you with your taxable income. Your tax is then calculated using tax tables and other rules.
With income generally in the $100,000 to $200,000 range ore more, you may also hit alternative minimum tax (AMT). In simple terms, AMT is a parallel tax system that has a different set of rules and allows less deductions. You calculate the AMT system on every return. If the AMT tax calculation yields a larger tax bill than the regular system, you pay the incremental difference as alternative minimum tax. Real estate taxes and miscellaneous itemized deductions subject to two-percent such as unreimbursed employee business expenses are common items that get kicked out in the AMT system.
Next you get to subtract any tax credits you may have. Tax credits are a dollar-for-dollar reduction of tax owed and are therefore more valuable than deductions, which only save you a fraction on the dollar. Depending on your circumstances there are credits for education, childcare, children in general, energy efficient upgrades, etc.
The next section is “Other Taxes.” There are a handful of other taxes people might incur , such as tax on taking money out of retirement plans too early, household employee taxes, repaying a first-time home buyer credit, etc. The most common, however, is self employment taxes. Business owners must pay the employer and employee side of their Social Security and Medicare taxes. After you add these taxes and determine your total tax liability, you then look at the payments section to see was has been paid in or credited to your account, and whether you will end up owing, or getting a refund.
At the bottom of the second page, you can choose things like direct deposit, or applying the payment to the following year. You can also designate a third party such as the tax preparer to be able to discuss the return with the IRS, if the IRS wants to discuss it. At the bottom, a paid preparer also has places to sign and fill out.
In two weeks we will start examining Schedule A – Itemized Deductions.
Prior articles are republished on my website at www.tlongcpa.com/blog.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Tax Changes on the Horizon?
Filed under: Tax Rates, Trusts and Estates | Tags: Alternative Minimum Tax, AMT, Bush Tax Cuts, Capital Gains, Clawback, Estate Tax, expire, Gift Tax, payroll rates, Tax Policy Center, tax rate increase
Leave a comment Originally published in the Cedar Street Times
October 19, 2012
Unless you have been hiding under a rock, you are sure to have heard the hubbub surrounding potential tax increases in 2013. These tax increases do not require Congress to take action, but to gridlock and do nothing, which is why they stand a much better chance of actually occurring than a concerted effort to raise taxes. Most of the increases are the result of the expiration of the temporary tax decreases dubbed “The Bush Tax Cuts,” passed in 2001 and 2003 while George W. Bush was in office. There was also a two percent reduction in payroll taxes a few years ago that was meant to be a temporary stimulus for the economy. The Tax Policy Center estimates that nearly 90% of American households will face an average tax increase of $3,500 if the tax cuts expire.
If current legislation stays in place, ordinary income tax brackets will jump 3-5%, depending on your bracket. Capital gains tax will increase 5-15%, depending on your bracket, and there will be a new Medicare surtax, generally for people making over $200,000, of another 3.8% on net investment income.
Alternative Minimum Tax (AMT) is another big issue that could affect most Americans. AMT is a parallel tax calculation that runs alongside the normal system, cutting out common deductions, and if it results in a higher overall tax liability, you pay the incremental difference as additional tax.
Estate and lifetime gift tax will also get hit hard. Currently, there is a $5,120,000 exemption for the combined estate and gift tax. If you have a taxable estate above that and you pass away by December 31, the excess will be taxed at a top rate of 35%. Next year, this exemption reverts to $1,000,000 with a maximum tax rate of 55% on your taxable estate above that figure.
This certainly presents questions for you, your tax professional, and your estate planner to analyze. If you knew ordinary tax rates, capital gains, and estate tax rates were going to rise next year, you would likely try to push expected income from next year to this year, sell your stocks now that could result in a gain in the future, and gift money from your estate to your heirs. It is not quite this simple, and you should get professional assistance, but it is something to think about now rather than December 31st.
Related to the estate and gift tax issue, on Saturday morning, October 27th, I will be presenting with local attorney, Kyle A. Krasa, and local investment advisor, Henry Nigos, in a free seminar titled “Opportunities and Clawbacks – Taking Advantage of the Once-in-a-Lifetime 2012 Estate/Gift Tax Rules” from 10:00 am to 11:30 am at 700 Jewell Avenue, Pacific Grove. The seminar is sponsored by Krasa Law – please RSVP at 831-920-0205.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Lost in Transition
Filed under: Switching Preparers | Tags: AMT, basis in retirement contributions, carryovers, Changing tax preparers, charitable deductions, depreciable assets, foreign tax credits, general business credits, net operating losses, office-in-home, passive activity losses, refunds, state tax payments
Leave a comment Originally Published in the Pacific Grove Hometown Bulletin
March 16, 2011
In my experience in the tax profession and from my vantage point as a Certified Public Accountant, I can tell you stories that will make your heart sing. I can also tell you stories that will make you shudder like you just heard a bad contestant on American Idol. The stories that make you cringe are usually caused by moments of stupidity by other tax preparers, or sadly, by people losing at a game of Tax Return Russian Roulette1. I like to think the stories of hearts singing involve me riding in on a metaphorical white horse to save the day, heralding a banner “To correct stupidity and promote safety locks on roulette guns…” I grant you, it is an unusual banner.
If I may spare you some pain, dear reader, I would say be mindful of transitions between tax preparers (including yourself) – particularly if you are “downgrading” the type of preparer you use. Over the years I have seen countless returns where valuable tax attributes from prior returns were not carried forward to the next year’s returns by a new preparer (effects ranging from hundreds to several hundred thousand dollars in tax). Some of you may be under the impression that your tax returns each year are distinct; this is rarely true.
Let us look at a simple example and suppose that you bought or inherited some mutual funds in 2007 worth $11,000; you sold them in 2009 for $6,000 resulting in a $5,000 loss. There is a good chance you would have been limited to using $3,000 of this loss in 2009 and the other $2,000 would have been a capital loss carryover to your 2010 returns that could save you $500 or more in tax. Of course, if you switch preparers and the new preparer does not have the training or presence of mind to find the Schedule D from 2009 and look for any unused capital losses, the cost of your new tax preparer just went up by $500. Sadly, you probably would never know a costly mistake was made.
There are many areas similar to the above item including: carryovers of net operating losses, basis in retirement contributions and depreciable assets, state tax payments or refunds, office-in-home expenses, charitable contributions, rental property expenses (passive activity losses), alternative minimum tax (AMT) credits, foreign tax credits, general business credits, etc. Often there are different amounts for the federal and state returns, and perhaps even AMT amounts for each of those if you are or may become subject to AMT. Unfortunately these are scattered throughout forms in the return, and just because your new preparers show you comparative figures in a tax summary when you pick up your returns, does not mean they entered any of the carryovers in their software.
You do not have to be rich or have a complicated return to be affected by a number of these. However, it does generally hold true, that the more money you make and the more types of activities you are involved with (rental properties, investments, etc.) the more heavily you are affected.
If you are doing the returns yourself with tax software for the first time, look carefully through the returns for hints of the above mentioned items, and be very diligent in answering the tax software questions. Also, be wary of deleting items you think you no longer have, as they may have carryover or suspended items attached to them. One of your big challenges is to know what the returns are supposed to look like when you are through. If you are switching preparers, make sure the new preparer is qualified. You may want to ask what specific carryover information was picked up from the old returns.
Let it be said of you, “You have chosen…wisely.” I hope I do not have to saddle up my white horse on your behalf, as I still prefer a regular appointment.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950. He can be reached at 831-333-1041.
1 Tax Return Russian Roulette – noun – a form of legalized gambling with generally poor odds whereby untrained participants willingly subject themselves to cruel and unusual punishment in the form of self-tax preparation, risking thousands of dollars in order to save hundreds.
Travis H. Long, CPA, Inc. Blog 