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Q: Investments and the Alternative Minimum Tax ( Answered 5 out of 5 stars,   0 Comments )
Question  
Subject: Investments and the Alternative Minimum Tax
Category: Business and Money > Finance
Asked by: bluesteel101-ga
List Price: $50.00
Posted: 14 May 2005 13:07 PDT
Expires: 13 Jun 2005 13:07 PDT
Question ID: 521656
An individual is an aggressive investor and usually is subject to the
Alternative Minimum Tax.  Their adjusted gross income is $175,000, and
they want to reduce their tax liability.

They have some options for investments to generate after-tax returns
and lower thier liability as follows:

1. Tax-exempt local private activity bonds, paying nearly a full
   percentage point more than comparable municipal bonds available.
2. A universal life insurance policy, currently they do not have a policy.
3. A capital growth mutual fund.
4. A luxury condominium investment with a small negative cash flow,
   but substantial depreciation deductions.
5. A risky working interest in an oil drilling program with large
   write-offs available up front.
6. Incentive stock options

Question: How would each of these investments impact a current tax
year calculation for both the Alternative Minimum Tax and the Regular
Tax?  And are any of these viable options for reducing their overall
tax liability?
Answer  
Subject: Re: Investments and the Alternative Minimum Tax
Answered By: richard-ga on 15 May 2005 08:48 PDT
Rated:5 out of 5 stars
 
Hello and thank you for your question.

The individual's marginal rate for regular income tax is 33%
(if the individual were married the marginal rate for regular income
tax would be 28%).
http://www.irs.gov/formspubs/article/0,,id=133517,00.html

The individual's rate (it's a flat tax) for alternative minimum tax is
26% (once AGI exceeds 175,000 it's 28%)
http://www.irs.gov/pub/irs-pdf/f6251.pdf
http://www.irs.gov/taxtopics/tc556.html

It's the tax preference items in the tax return that subject a taxpayer to AMT
http://www4.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000057----000-.html

Question 1.
A 'comparable' municipal bond would be tax-free for both regular tax
and AMT.  But private activity bonds do incur AMT.  So that extra
percent of yield subjects the entire yield to AMT.  So if the
comparable municipal yields 3% and the private activity bond yields
4%, and assuming a $10,000 bond, the comparison is 300 tax free or 400
AMT net 400 * .74 = 296.
So the regular muni bond is a better choice.
http://www.irs.gov/publications/p17/ch32.html#d0e74262

Question 2.
Universal life insurance.  Premiums paid are non-deductible, but the
cash value of the investment fund will grow tax-free for both AMT and
regular tax purposes.  So like the regular municipal bond future
growth will be tax free.
http://www.professionalreferrals.ca/article-121.html

Question 3
Capital growth mutual fund, i.e. capital gains distributions
For capital gains, the capital gains rates for the regular tax are used. 
http://www.irs.gov/taxtopics/tc556.html
So the mutual fund will not provide tax shelter, apart from the
benefit of favorable capital gains rates, 15%
http://www.irs.gov/businesses/small/article/0,,id=110431,00.html

Question 4
Luxury condo - - depreciation (I assume this is not a personal
residence, which could not be depreciated, so it must be property held
for investment.
"Line 17, Post-1986 Depreciation: On this line, you enter the
depreciation difference for regular and AMT purposes. For AMT
purposes, you generally must depreciate (deduct) business assets over
a longer period of time than you can for regular tax purposes. This
creates a difference between regular tax depreciation and AMT
depreciation. This is an entry that does self-correct. By the time the
asset is completely written off, you have received the same deduction
for both regular and AMT purposes.
Suggestion: If you have an entry on this line, consider electing a
slower depreciation method for your business assets, which could
eliminate the AMT adjustment."
http://www.turbotax.com/articles/FAQontheAlternativeMinimumTax.html

"Example 9 in the MSSP audit guide, a simple example for only one
asset, illustrates the information an auditor might request. Samantha
is an independent court reporter. On June 6, 1994, she purchases and
places into service a new word processor that costs $6,500. For
regular tax purposes, depreciation was computed on a 200% declining
balance, five-year property basis, as follows:

Year Basis Percentage Depreciation 
1  $6,500 20% $1,300 
2 6,500 32 2,080 
3  6,500 19.2 1,248 
4 6,500 11.52 749 
5 6,500 11.52 749 
6  6,500 5.76 374 


For AMT purposes, depreciation was computed as follows: 

Year  Basis Percentage Depreciation 
1 $6,500 15% $975 
2 6,500 25.5 1,658 
3 6,500 17.85 1,160 
4 6,500 16.66 1,083 
5  6,500 16.66  1,083 
6 6,500 8.33 541 

The difference between regular and AMT depreciation will require a
positive or negative adjustment each year as follows:

Year  Regular AMT AMT Adjustment 
1 $1,300 $ 975 $325 
2 2,080 1,658 422 
3 1,248 1,160 88 
4 749  1,083 (334) 
5  749 1,083 (334) 
6  374 541 (167)"
http://www.nysscpa.org/cpajournal/2000/1200/features/f123000a.htm

Question 5
Oil depletion
"The alternative minimum tax treats both the excess of percentage
depletion over cost basis[Except for independent oil and gas
producers. See IRC 57(a(1)] and excess intangible drilling costs as
preference items.[See IRC 57(a)(2]"
http://www.fairtaxvolunteer.org/smart/oilandgas.html
http://www4.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000057----000-.html

Question 6.
Incentive Stock Options
"If you are granted a statutory stock option under an employee stock
purchase plan or an employee incentive stock option (ISO) plan, you
generally do not include any amount in your gross income as a result
of the grant or exercise of your option. However, you may be subject
to Alternative Minimum Tax in the year you exercise an ISO. For more
information, refer to the Instructions for Form 6251."
http://www.irs.gov/taxtopics/tc427.html
http://www.irs.gov/pub/irs-pdf/i6251.pdf
[page 2, re: line 13]

Search terms used:
2005 alternative minimum rate site:irs.gov
"alternative minimum" "Universal life" 
 "alternative minimum" "capital gains" site:irs.gov
 "alternative minimum" "amt depreciation " 
 "alternative minimum" "depletion" oil 
form 6251 instructions


Thanks again for letting us help; I hope you find the above answer and
citations useful.

Sincerely,
Google Answers Researcher
Richard-ga

Request for Answer Clarification by bluesteel101-ga on 15 May 2005 09:53 PDT
Richard - 
Great Stuff!
So if I read correctly, Option 4 is the only one that would reduce the
overall tax liability?

Clarification of Answer by richard-ga on 15 May 2005 13:30 PDT
That's right - - except you could say the universal life is saving
taxes if it's replacing a taxable and/or AMT taxable investment.

-R
bluesteel101-ga rated this answer:5 out of 5 stars
Richard -
You were a great help!  I have another question posted that deals with
the AMT versus the Regular tax if you are available.  Thanks again!

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