"I Never Heard Of The Alternative Minimum Tax"

 

I am looking at a case that involves the alternative minimum tax.

While it still exists, much of the steam has thankfully been taken out of the AMT. It started off as Congressional reaction to a handful of ultrawealthy families paying little to no income taxes decades ago. Congress’s response was to require a second tax calculation, disallowing certain things – such as exemptions for your dependents.

Yes, you read that correctly, you large-family tax scofflaw.

Now, it wouldn’t be so bad if this thing had been scaled to only reach the wealthy and ultrawealthy, but that is not what Congress did. Congress instead gave you a spot, and then you were on your own. For 2017 that spot was approximately $84 grand in income for marrieds filing jointly.

I used to see the AMT as often as a Gibson’s employee sees donuts.

Thankfully the Tax Cut and Jobs Act of 2017 did a couple of things to defang the AMT:

(1) It increased the exemption (that is, the spot) for everyone. Marrieds now have an exemption of approximately $115,000, for example.

(2)  More importantly, it adjusted a previous rule that phased-out the exemption as one’s income increased. For example, marrieds in 2017 would start phasing-out when their income reached approximately $160,000. Now it is over $1 million, which makes a lot more sense it if was truly targeted at the wealthy.

Why the absurdly low previous income thresholds for the AMT, especially since it was supposed to target the “rich?” Think of it as Congressional addiction to paper crack – the paper being your dollar bills.

The tax law is a little saner until 2026, when the TCJA goes “poof.” Much prior tax law will then resurrect – including the previous version AMT.

Robert Colton and Alina Mazwin (R&A) filed a joint return for 2016.

The IRS did its computer matching and sent them a notice. There was $125,000 reported by JP Morgan Chase Bank. The IRS wanted taxes on it.

R&A explained to the IRS that the $125,000 was a legal settlement, and that half of it went to Mr Colton’s ex-spouse.

The IRS said OK, but we want taxes on the $62,500.

Let’s take an aside here. You may have heard that lawsuit settlements are not taxable. That is only partially true. The lawsuit has to involve physical injury (think a car crash, for example) to be tax-free.

It appears that Mr Colton’s settlement was of the non-car crash variety, meaning that it was taxable.

R&A then amended their 2016 return, picking up the $62,500 but also claiming a miscellaneous itemized deduction of $80,075 for attorney fees.

Hah! They might even get a tax refund out of this, right? Take that, IRS.

Except …

Guess what is not deductible for the AMT.

Yep, that miscellaneous itemized deduction.

So – for AMT purposes – their income went up by the $62,500 but there was no deduction for the related legal fee.

How much income did R&A have before the IRS contacted them?

About $40 grand.

Yep, the AMT had been bent so far beyond recognition that it trapped someone amending a return to show perhaps $100 grand in income.

Folks, that income level does not go you invited to the cool parties on Martha’s Vineyard.

Let me share a line from the case:

Petitioners stated in their petition that ‘[they] never heard of [the] alternative minimum tax.”

I get it. I consider it unconscionable that an average person has to hire someone like me to prepare their taxes.  

Our case this time for the home gamers was Colton and Mazwin v Commissioner, T.C. Memo 2021-44.

Wal-Mart Sues Puerto Rico Over Tax Changes

I had seen the headline, but it was busy season and there were other priorities.

Now I have had time to look into the matter.

I am referring to the Wal-Mart v Zaragoza-Gomez decision. It has to do with Puerto Rican taxes.

You may know that Puerto Rico is a U.S. territory. I have bumped into it professionally only a couple of times over the last dozen or so years. It simply is not a component of my practice.

What you may not know is that Puerto Rico has its own taxes. It is similar to a state in that regard, but there are differences. For example, if you are a resident of Puerto Rico you do not have to file a U.S. tax return – unless you have income in the U.S. You then file a U.S. return, but only for the U.S. income.

Puerto Rico however is now on the precipice of bankruptcy. They decided to bring-in more money to the fisc by changing a tax rule or two:

·        Tripling the “tangible personal property” tax rate from 2.5% to 6.5% on purchases from vendors located off the island.

·        Eliminating the option for the Treasury Secretary to exempt, in whole or part, a 20% tax on services provided by related entities or by a home office upon proof that the price charged was equal or substantially similar to the price which would occur with an unrelated person.

There was a problem, however: the tax, as changed, applied to only one taxpayer: Wal-Mart.

Granted, Wal-Mart is also the island’s largest corporate taxpayer, but one would think the politicians would employ some … deniability … before they culled the Arkansan wildebeest from the herd. Shheessssh.

Now, 6.5% does not sound like a lot, but I suppose one has to specify what it is being multiplied against. 

·        If net profit, that would leave 93.5% of profit left over. That is pretty good.

·        If cost of sales, then we need one more piece of information.

We need to know the gross profit.

Say that you bought something for $93. You sold it for $100.  Your gross profit is $7. Now you have to pay tax. That tax is calculated as 6.5% times $93 or slightly over $6. Your profit was $7.

That is not so good.

Wal-Mart said that the effect of the changes was an effective tax rate of over 90%, so I am thinking we are not too far off with the above example.

Wal-Mart did what it had to do: it sued.

The District Court was sympathetic to Puerto Rico’s financial plight:

·        It gives us no pleasure, under these circumstances, to enjoin a revenue stream that flows directly into Puerto Rico’s general fisc.”

·        … we, too, are citizens of this island and we, too, must suffer the consequences….”

·         … we are here because … has left the plaintiff, Wal-Mart, with nowhere else to turn.”

The government argued that Wal-Mart would simply have to pay the tax and sue for refund. Wal-Mart’s argument was “not yet ripe,” as it had not been denied a refund of its taxes. Furthermore, Wal-Mart could “afford to pay” the tax.

The Court pointed out the obvious: it would likely take a generation for the case to resolve, at which point Puerto Rico might be as able to repay Wal-Mart as it is to have winter sports. 

This is not a remedy, but a cynical means of extracting more unconstitutional revenue from an innocent taxpayer without the deterrent effect of having to pay it back…,” said the Court.

The government said it would appeal.

The judge just took away $100 million from the people of Puerto Rico and gave it to Wal-Mart. Now I have to look for that money somewhere else,” said Governor Alejandro Garcia Padilla.

I have no particular sympathy for Wal-Mart, other than the deep belief that any government desirous of being perceived as legitimate is mandated to deal fairly with its citizenry. Taxation is especially sensitive, and this is the equivalent of having you pay for all the new sidewalks in the neighborhood because you have the nicest house.

Smart person moves out of the neighborhood.

What Are The New Individual Income Taxes?

Congress has given us a new tax bill – the American Taxpayer Relief Act of 2012. It was passed by the Senate at approximately 2 a.m. on January 1 and ….. Actually, that fact alone tells you about the quality of this tax bill.

Let’s take a look at some individual tax measures.

(1)   The 2% social security tax reduction is gone. Everybody with a paycheck will immediately see their take-home pay go down.

(2)   The previous tax rates of 10/15/25/28/33/35 percent still exist, but ….

a.      There is a new 39.6% tax rate.

NOTE: The new rate starts at $400,000 for singles and $450,000 for marrieds.

(3)   The qualified dividends and capital gains rates do not change UNLESS…

a.      … you make more than $400,000 for singles and $450,000 for marrieds.

b.      If this is you, your NEW qualified dividends and capital gains tax rate will be 20%.

OBSERVATION:  Let’s be fair: 20% is not a bad tax rate.

You may have noticed that the above three changes pivot on $400,000/$450,000.

QUESTION: Can we rely on this throughout the new law?  

ANSWER: Silly you. Of course not.

(4)   Phaseout of your personal exemptions

Tax pros call this the “PEP,” and it is the brilliant idea to reduce (if not eliminate) your exemptions for yourself, your spouse, your kids and anyone else – once you go past a certain income.

QUESTION: What is that income level?

ANSWER: $250,000 for singles and $300,000 for marrieds.

(5)   Phaseout of your itemized deductions

You have the same reasoning as (4), but this time we are talking about reducing your itemized deductions. These are your mortgage, real estate taxes, contributions and so on.

QUESTION: What is that income level?

ANSWER:  $250,000 for singles and $300,000 for marrieds.

(6)   Alternative Minimum tax

Congress reset the exemption amounts to $50,600 for singles and $78,750 for marrieds – about in line with 2011.

This is good news because – if Congress did nothing – the exemption amounts were scheduled to decrease drastically. This would have pulled millions more people into the AMT, even with the same income as 2011 and would have made for some stressful client conversations.

Congress has also linked the AMT exemption and phaseout levels to an inflation factor. Finally and thank goodness.

Frankly, in my opinion the AMT may be the most important thing Congress did with individual taxes in this legislation.

(7)   Coverdell IRAs

a.      Remain at $2,000 rather than reverting to $500

b.      As an FYI, these are the “education” IRAs

(8)   Employer provided education

a.      The exclusion from income is renewed at $5,250.

NOTE: This will make a Tax Guy’s wife happy as she returns for her Master’s.

(9)   Student loan interest

a.      Remains deductible up to $2,500

(10)  The American Opportunity tax credit     

a.      Is renewed up to $2,500

NOTE: Good news for a Tax Guy with a daughter in college

(11)    The $250 supplies deduction for elementary and secondary school teachers

a.      Is renewed

(12)    Mortgage debt exclusion from income

a.      Up to $2 million is renewed but for 2013 ONLY

(13)    The sales tax deduction in lieu of income tax deduction

a.      Is renewed

b.      Good news if you live in Florida, which does not have an income tax

(14)    Above-the-line deduction for higher education

a.      Up to $4,000 – if you can meet the income limits

(15)    Child credit

a.      Stays at $1,000 per child rather than dropping to $500

Let’s go back a moment to the 39.6% tax rate (income of $400,000/450,000) and the PEP/Pease (income of $250,000/300,000).  In addition to this spaghetti, there are two NEW taxes in 2013. They are NOT in this bill because they already existed and were waiting to hatch, like something in the movie Aliens. They are ADDITIONAL taxes on top of the above. They are:

(1)   If your income goes above $200,000 for singles and $250,000 for marrieds, there will be a new 3.8% tax rate on your interest, dividends, capital gains and investment income of that type. This was courtesy of ObamaCare.

(2)   If your income goes above $200,000 for singles and $250,000 for marrieds, there will be a new 0.9% tax on your salary for additional Medicare. This too is courtesy of ObamaCare.

Did you see what Congress did here? Look at the income thresholds on some of these taxes:

               $200,000/$250,000

               $250,000/$300,000

               $400,000/$450,000

Try remembering all that and doing the math in your head whenever you get a client phone call.

Notice what the “true” top federal tax rate is: 39.6% plus 3.8% plus 0.9% plus 1.2% (approximate PEP/Pease effect) equaling 45.5%. This is Congress' thing now: sneaking taxes on you through the back door.

We will go over the business tax provisions with another blog.

What Will The Tax Cliff Cost You?

The Tax Foundation has published an analysis on the impact of the tax cliff on a typical family in each state.

To arrive at the typical family, the Tax Foundation used Census and IRS data to estimate income and deductions for an average two-child family in each state.

They then ran those numbers through two tax calculations: the first using 2011 tax law, and the second using projected 2013 law. The rub of course is the 2013 law, as Bush-era and Obama tax cuts are expiring. It is unknown what, if anything, will take its place. This is the “taxmaggedon” you may have read about. Another key piece to 2013 is the alternative minimum tax (AMT), as the most recent AMT “patch” expires with the 2012 tax year.

The rankings go from #1 to #50, and one does not want to be #1. That dubious distinction goes to New Jersey, not exactly an economical place in which to live under the best of circumstances.

In our corner of the world, the TriState area (Ohio, Kentucky and Indiana) came in as follows:

                                                $ Increase                                 % Increase

Ohio                                          $3,437                                       4.72%

Indiana                                     $3,653                                       5.27%

Kentucky                                  $3,437                                       5.18%

So – if the politicians accomplish nothing – the tax cliff will cost the average TriStater approximately $300 per month. This is real money, folks.

Small Business Health Care Tax Credit Redux

We’ve been looking again at the small business health care tax credit. Truthfully, I have been less than impressed with this credit, at least for our clients. It seems quite heavily engineered to accomplish so little.

There are three key steps to this credit:

(1)    How many employees do you have?

(2)    How much do you pay them?

(3)    Do you have a “qualifying” insurance arrangement?

Let’s go through them.

HOW MANY EMPLOYEES DO YOU HAVE?

To be fair, the credit does not address the number of employees. It instead addresses “full time equivalents.” This makes sense, as it may require two (or three) part-time employees to have one “full-time equivalent” employee.

The first thing to do is count the number of employees. This requires a definition of “employee” (remember, this is the tax code). The term “employee” does NOT include the following:

·         a sole proprietor

·         a partner in a partnership

·         a more-than-2% shareholder in an S corporation

·         a more-than-5% owner in any other business

Wait, there is more:

·         a family member of the above, including spouses, lineal family (ancestor/descendent) and in-laws.

So, you start with your year-end payroll summary. You eliminate the owners and their family. That leaves you with “employees’ for purposes of this credit.

Next you add-up the hours worked for those who remain. You stop counting at 2,080 hours per employee. After you adding-up all the hours, you divide by 2,080 to arrive at the number of FTEs. If this number is less than 25, you are still in the hunt.

The magic number is 10 or less FTEs. Above that number you will start to phase-out. By 25 you have phased-out completely.

HOW MUCH DO YOU PAY THEM?

We are talking Medicare wages, not income-taxable wages. The key difference will be contributions to 401(k)s, as those are Medicare-taxable but not income-taxable.

Fortunately you get to exclude the wages for the people left out above: the owners, their spouses and other family.

This can get you into an odd factual situation. You can have a workforce over 25 people – all full-time – and still qualify for this credit. The reason is that you have to eliminate the owners, their spouses and family. For some of our clients, that eliminates a sizeable part, if not the majority, of the workforce.

The key number here is $25,000 per FTE.  Above that amount you will start to phase-out.  By $50,000 you have completely phased-out. 

DO YOU HAVE A “QUALIFYING”INSURANCE ARRANGEMENT?

The insurance we are discussing is what you would anticipate: traditional insurance, HMO, PPO and hospital indemnity. It also includes specified illness (think cancer insurance) as well as some dental and vision insurance.

What it doesn’t include is an HSA.

The key requirement is that you – the employer - have to pay at least 50% of the cost of the insurance. There are some tweaks around the edges (such as if the insurance company does not charge the same premium for all employees in single coverage).

If you do not pay at least 50% of the health insurance, there is no point in even starting the calculation.

There is also a “ceiling” test: your insurance can only be so expensive for purposes of this calculation. The government will publish state-specific amounts for “small group market average premiums.” Your insurance cannot exceed that amount for your state.

AN INTERIM STEP

Add-up your cost of premiums for “qualifying” insurance for your “FTEs.”

WHAT IS THE AMOUNT OF THE CREDIT

If you are for-profit, the credit is 35% of the interim step.

ARE WE DONE?

Of course not. If you have too many employees – or the right number of employees but pay them too much – your credit gets phased-out, eventually to zero. No credit for you.

There are two phase-outs, which means that you cannot do this in your head.

(1)    If you have more than 10 FTE’s you start to phase-out. The phase-out is

(FTE – 10)

15

                                So, at 25 FTE’s you are completely phased-out.

(2)    If your average wage is more than $25,000, you start to phase-out.

(average annual wage - 25,000)

25,000

                                So, at $50,000 you are completely phased-out.

HOW ABOUT AN EXAMPLE?

Let’s say that you have 9 FTEs with an average wage of $23,000.

4 are single coverage and 5 are family coverage. You pay 50% of the single rate.

The premiums are $4,000 for singles and $10,000 for family. The state limits are $5,000 for singles and $12,000 for family.

Here is the calculation.

                                $2,000 times 9 equals                     18,000

The credit is 35% times 18,000 or $6,300.                      

LET’S CHANGE AN ASSUMPTION

What if the employer pays 50% whether of single or family coverage?

Here is the calculation:

                                $2,000 times 4 equals                     8,000

                                $5,000 times 5 equals                   25,000

                                                                                           33,000

The credit is 35% times 33,000 or $11,550.                    

HOW ABOUT ANOTHER EXAMPLE?

Let’s say you have 40 part-time employees. They total 20 FTEs. The average wage is $25,000. To keep this easy, let’s say that your cost of the health insurance is $240,000

(1)    First phase-out

20 FTE - 10                           equals 66.6% phase-out

15

(2)    Second phase-out

$25,000 - $25,000              equals 0% phase-out (that’s good!)

$25,000

The credit is (35% times $240,000) times (100% minus 66.6%) times (100% minus 0%) - or $28,000.

MISCELLANEOUS

The credit is part of the general business credit, which means that you get to carry it over if you cannot use it in a given tax year. In addition, the credit is allowed for AMT, which is good. You do have to reduce your deductible insurance by the amount of the credit.

As I said, we have been less than impressed. It is, however, a great way for Congress to increase someone’s tax preparation fees.