AMT tax trap avoidance.

Facts: In preparing Tom Smythe's 2001 return, his tax adviser notices that Tom has large deductions relative to income. The tax adviser wonders if Tom might be subject to the alternative minimum tax (AMT) for 2001.

Analysis: The AMT has long complicated return preparation. While all

practitioners are presumably familiar with the AMT, it is a good idea to review some of the traps that exist. For individuals, the AMT traps usually involve the difference between AMT itemized deductions and itemized deductions for regular tax purposes, along with personal exemptions. Also, depreciation and certain income-recognition rules offer their own complexities. The checklist that follows includes AMT traps practitioners should consider when examining client data.

AMT Checklist for Individual Returns

Client Name: --    Tax Year: --
Prepared by: --    Reviewed by: --

                           Trap                                     Yes

1. Itemized deductions
Comment: Casualty losses, wagering losses (to the extent of
reported winnings) and charitable contributions are
allowed in full for both regular tax and AMT. For other
itemized deductions, determine whether any of the fol-
lowing adjustments are needed:
a. Interest expense on home-equity loans deducted for
   regular tax, but not for AMT. (However, consider
   whether such interest can be reclassified as business or
   investment interest to make it deductible for AMT
   purposes, too.)                                                   --
b. Interest expense on a boat treated as a second home
   for regular tax, but not deductible when calculating
   AMT (Sec. 56(b)(1)(C)(i)and (e)(2)).                              --
c. Investment-interest expense limit increased by
   amount of private-activity-bond interest included in
   alternative minimum taxable income (AMTI) (thus,
   possibly allowing a larger investment-interest expense
   deduction for AMT purposes, if deduction was limited for regu-
   lar-tax purposes) (Sec. 56(b)(1)(C)(iii)).                        --
d. Medical expenses deducted for AMT only to the extent they
   exceed 10% of adjusted gross income (AGI) (7.5%-of-AGI floor
   applies for regular-tax purposes) (Sec. 56(b)(1) (B)).            --
e. State and local taxes deducted for regular tax but not
   deductible for AMT (Sec. 56(b)(1)(A)(ii)).                        --
f. Miscellaneous deductions claimed on Schedule A are not
   deductible for AMT (Sec. 56(b)(1)(A)(i)).                         --

2. Basis and loss adjustments
a. Has the basis of any depreciable asset sold during the year
   been adjusted for differences between regular-tax and AMT
   depreciation?                                                     --
b. If suspended passive losses were deducted for regular tax,
   were adjustments made to account for any differences between
   the regular-tax and AMT suspended passive loss carryforwards?     --
c. Has the separately calculated AMT net operating loss (NOL), if
   any, rather than any regular-tax NOL, been claimed on Form
   6251, Alternative Minimum Tax--Individuals?                       --
d. The annual $3,000 net-capital-loss limits applies when
   computing both regular-tax and AMT capital gains and losses.
   This can be a factor when determining the AMT adjustment due
   to gains and losses from the sale of property.                    --

3. Income recognition and deduction
a. If a state or local income tax refund was included in regular
   taxable income, has the refund been backed out for AMT
   purposes? The only taxes deductible for AMT purposes are
   Federal estate taxes on income in respect of a decedent and
   certain generation-skipping taxes.                                --
b. Have incentive stock options been exercised in the current
   year? The excess of the stock's fair market value over the
   option price at exercise is a preference item (Sec. 56(b)(3)).    --
c. Has gain from qualified small business stock been excluded?
   42% of the excluded gain is added back for AMT purposes (Sec.
   57(a)(7)).                                                        --
d. Has the tax-exempt interest from any private activity bonds
   been included for AMT (Sec. 57(a)(5))?                            --
e. Have appropriate adjustments been made for any item of income
   or deduction limited by something other than AGI or modified
   AGI? See Regs. Sec. 1.55-1.                                       --

4. Filing status
Is the taxpayer's filing status married filing separately (MFS),
with AMTI greater than $173,000? A taxpayer who files MFS and
whose AMTI exceeds $173,000 not only has his AMT exemption
completely phased out, but must add an additional amount to AMTI
(Sec. 55(d)(3)). The additional amount is the lesser of (1) 25%
of the AMTI excess over $173,000 or (2) $24,500. Thus, if AMTI
exceeds $271,000, the maximum amount of $24,500 must be added to
the AMTI.                                                            --

                           Trap                                      No

1. Itemized deductions
Comment: Casualty losses, wagering losses (to the extent of
reported winnings) and charitable contributions are
allowed in full for both regular tax and AMT. For other
itemized deductions, determine whether any of the fol-
lowing adjustments are needed:
a. Interest expense on home-equity loans deducted for
   regular tax, but not for AMT. (However, consider
   whether such interest can be reclassified as business or
   investment interest to make it deductible for AMT
   purposes, too.)                                                   --
b. Interest expense on a boat treated as a second home
   for regular tax, but not deductible when calculating
   AMT (Sec. 56(b)(1)(C)(i)and (e)(2)).                              --
c. Investment-interest expense limit increased by
   amount of private-activity-bond interest included in
   alternative minimum taxable income (AMTI) (thus,
   possibly allowing a larger investment-interest expense
   deduction for AMT purposes, if deduction was limited for regu-
   lar-tax purposes) (Sec. 56(b)(1)(C)(iii)).                        --
d. Medical expenses deducted for AMT only to the extent they
   exceed 10% of adjusted gross income (AGI) (7.5%-of-AGI floor
   applies for regular-tax purposes) (Sec. 56(b)(1) (B)).            --
e. State and local taxes deducted for regular tax but not
   deductible for AMT (Sec. 56(b)(1)(A)(ii)).                        --
f. Miscellaneous deductions claimed on Schedule A are not
   deductible for AMT (Sec. 56(b)(1)(A)(i)).                         --

2. Basis and loss adjustments
a. Has the basis of any depreciable asset sold during the year
   been adjusted for differences between regular-tax and AMT
   depreciation?                                                     --
b. If suspended passive losses were deducted for regular tax,
   were adjustments made to account for any differences between
   the regular-tax and AMT suspended passive loss carryforwards?     --
c. Has the separately calculated AMT net operating loss (NOL), if
   any, rather than any regular-tax NOL, been claimed on Form
   6251, Alternative Minimum Tax--Individuals?                       --
d. The annual $3,000 net-capital-loss limits applies when
   computing both regular-tax and AMT capital gains and losses.
   This can be a factor when determining the AMT adjustment due
   to gains and losses from the sale of property.                    --

3. Income recognition and deduction
a. If a state or local income tax refund was included in regular
   taxable income, has the refund been backed out for AMT
   purposes? The only taxes deductible for AMT purposes are
   Federal estate taxes on income in respect of a decedent and
   certain generation-skipping taxes.                                --
b. Have incentive stock options been exercised in the current
   year? The excess of the stock's fair market value over the
   option price at exercise is a preference item (Sec. 56(b)(3)).    --
c. Has gain from qualified small business stock been excluded?
   42% of the excluded gain is added back for AMT purposes (Sec.
   57(a)(7)).                                                        --
d. Has the tax-exempt interest from any private activity bonds
   been included for AMT (Sec. 57(a)(5))?                            --
e. Have appropriate adjustments been made for any item of income
   or deduction limited by something other than AGI or modified
   AGI? See Regs. Sec. 1.55-1.                                       --

4. Filing status
Is the taxpayer's filing status married filing separately (MFS),
with AMTI greater than $173,000? A taxpayer who files MFS and
whose AMTI exceeds $173,000 not only has his AMT exemption
completely phased out, but must add an additional amount to AMTI
(Sec. 55(d)(3)). The additional amount is the lesser of (1) 25%
of the AMTI excess over $173,000 or (2) $24,500. Thus, if AMTI
exceeds $271,000, the maximum amount of $24,500 must be added to
the AMTI.                                                            --

                           Trap                                     N/A

1. Itemized deductions
Comment: Casualty losses, wagering losses (to the extent of
reported winnings) and charitable contributions are
allowed in full for both regular tax and AMT. For other
itemized deductions, determine whether any of the fol-
lowing adjustments are needed:
a. Interest expense on home-equity loans deducted for
   regular tax, but not for AMT. (However, consider
   whether such interest can be reclassified as business or
   investment interest to make it deductible for AMT
   purposes, too.)                                                   --
b. Interest expense on a boat treated as a second home
   for regular tax, but not deductible when calculating
   AMT (Sec. 56(b)(1)(C)(i)and (e)(2)).                              --
c. Investment-interest expense limit increased by
   amount of private-activity-bond interest included in
   alternative minimum taxable income (AMTI) (thus,
   possibly allowing a larger investment-interest expense
   deduction for AMT purposes, if deduction was limited for regu-
   lar-tax purposes) (Sec. 56(b)(1)(C)(iii)).                        --
d. Medical expenses deducted for AMT only to the extent they
   exceed 10% of adjusted gross income (AGI) (7.5%-of-AGI floor
   applies for regular-tax purposes) (Sec. 56(b)(1) (B)).            --
e. State and local taxes deducted for regular tax but not
   deductible for AMT (Sec. 56(b)(1)(A)(ii)).                        --
f. Miscellaneous deductions claimed on Schedule A are not
   deductible for AMT (Sec. 56(b)(1)(A)(i)).                         --

2. Basis and loss adjustments
a. Has the basis of any depreciable asset sold during the year
   been adjusted for differences between regular-tax and AMT
   depreciation?                                                     --
b. If suspended passive losses were deducted for regular tax,
   were adjustments made to account for any differences between
   the regular-tax and AMT suspended passive loss carryforwards?     --
c. Has the separately calculated AMT net operating loss (NOL), if
   any, rather than any regular-tax NOL, been claimed on Form
   6251, Alternative Minimum Tax--Individuals?                       --
d. The annual $3,000 net-capital-loss limits applies when
   computing both regular-tax and AMT capital gains and losses.
   This can be a factor when determining the AMT adjustment due
   to gains and losses from the sale of property.                    --

3. Income recognition and deduction
a. If a state or local income tax refund was included in regular
   taxable income, has the refund been backed out for AMT
   purposes? The only taxes deductible for AMT purposes are
   Federal estate taxes on income in respect of a decedent and
   certain generation-skipping taxes.                                --
b. Have incentive stock options been exercised in the current
   year? The excess of the stock's fair market value over the
   option price at exercise is a preference item (Sec. 56(b)(3)).    --
c. Has gain from qualified small business stock been excluded?
   42% of the excluded gain is added back for AMT purposes (Sec.
   57(a)(7)).                                                        --
d. Has the tax-exempt interest from any private activity bonds
   been included for AMT (Sec. 57(a)(5))?                            --
e. Have appropriate adjustments been made for any item of income
   or deduction limited by something other than AGI or modified
   AGI? See Regs. Sec. 1.55-1.                                       --

4. Filing status
Is the taxpayer's filing status married filing separately (MFS),
with AMTI greater than $173,000? A taxpayer who files MFS and
whose AMTI exceeds $173,000 not only has his AMT exemption
completely phased out, but must add an additional amount to AMTI
(Sec. 55(d)(3)). The additional amount is the lesser of (1) 25%
of the AMTI excess over $173,000 or (2) $24,500. Thus, if AMTI
exceeds $271,000, the maximum amount of $24,500 must be added to
the AMTI.                                                            --

Editor's note: This case study has been adapted from "Tax Planning for High Income Individuals," 2nd Edition, by Anthony J. DeChellis, Douglas L. Weinbrenner, Catherine A. Roeder and Patrick L. Young, published by Practitioners Publishing Company, Fort Worth, TX, 2001 ((800) 323-8724; www.ppcnet.com).