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Alternative Minimum Tax ©2004 Dr. B. C. Paul. What is it?  Some tax breaks given to encourage business activity can be used so heavily as to shelter.

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Presentation on theme: "Alternative Minimum Tax ©2004 Dr. B. C. Paul. What is it?  Some tax breaks given to encourage business activity can be used so heavily as to shelter."— Presentation transcript:

1 Alternative Minimum Tax ©2004 Dr. B. C. Paul

2 What is it?  Some tax breaks given to encourage business activity can be used so heavily as to shelter all income from tax  Example off shore tax shelters  For Alternative Minimum Tax individuals figure taxes without the breaks  Calculate tax at a lower rate  The structure is intended to ensure that everyone pays a basic level of tax

3 AMT Today  Restructuring done late in Clinton Administration  AMT today used mostly for tax shelter busting  And creative finance tricks busting  Has in the past focused more on “excessive” tax breaks and deductions given to business and individuals

4 Example of AMT  This example uses some AMT practices that were amended significantly after 1999  Illustrate the use of AMT – not current tax law  AMT eliminates what are termed “Preference Items” from ones tax deductions

5 Starts Out the Same  Ordinary Gross Income $6,050,000  Take Away Expenses  We have two preference item on our Expenses  Intangible Drilling Costs $136,500  Must go 10 year straight line under AMT  Pre-production Development $250,000  Must go to units of production depreciation

6 Ordinary Income - Expenses  Ordinary Gross Income $6,050,000  No Change  Expenses $1,720,000  Were $2,106,500  Difference is preference item expensing not allowed  Net Ordinary Income Now $4,330,000

7 Depreciation  $1,700,000 worth of waste water equipment  MACRS life was 15 years  ADS life is 24 years  Alt min tax uses straight line and slower dep.  Since 1999 did allow MACR lives used on AMT  Not going to do that here  24 Year SL $1,700,000/24 = $70,834  Midyear convention take ½ this year  $35,417  Also had set up for $11,000,000  Since is WW treatment go with 24 year SL  $11,000,000/24 = $458,333

8 More Depreciation  1,500,000 for Mnt Doodo food processing equipment  MACRS was 7 year  ADR is 12 years  Straight lined gives $125,000  $250,000 for office equipment  5 year MACRS  6 year ADR  SL gives $41,667

9 Units of Production Depreciation  AMT accepts units of Production Depreciation  Old Working Deduction of $25,000 same  Did have to move new development out of expenses and into units of production depreciation  $250,000  If 10% used up this year  $25,000 (an additional deduction that could not be expensed)

10 Totaling Up Depreciation  $714,595  Under Reg Tax Depreciation was $1,175,150  Difference is the switch to longer depreciation lives and SL  (Actually under newer tax laws since 1999 have been able to use MACRS lives and same dep rate except DDB is replaced with 150% DB)

11 A Side Effect of Depreciation  When you sell a partially depreciated asset  If it sells for more than “book value” (original cost – depreciation taken)  Difference is taxable as a Capital Gain  Under AMT less depreciation is taken – result may well be less of a Capital Gain  Land was no different $325,000 gain  Equipment had an AMT “book value” of $1,000,000 so gain was $100,000 instead of $269,000

12 Amortization  Most amortization is fairly conservative and not lot of changes for AMT  We did shift an expense into amortization (the ITDC)  136,500 onto 10 year SL with Midyear convention  Deduction is $6,825  New Amortization Total $526,825  Was $520,000 for reg tax.

13 Depletion  There is no % depletion under AMT  Do have to keep second set of books because cost basis may change  In our case the original $350,000 worth of exploration could not be expensed and had to go into cost basis  Have $87,500 left this year  Also means we don’t have recapture under AMT  Our Depletion is $107,500  Was $50,000 based on % depletion after recapture under regular tax

14 Taxable Income  Net income $4,330,000  Minus depreciation $714,595  Minus amortization $526,825  Minus depletion $107,500  Taxable Ordinary Income $2,981,080  At 28% rate $834,702  Note that AMT gives fewer deductions but uses a lower tax rate (not 34% this time)

15 The Capital Gains  $425,000 in capital gains  For individuals AMT capital gains are at lower rates than reg income  For corporations they are not  Take 28% rate (still lower than 34%)  $119,000  Total up the tax $953,702

16 Comparing AMT to Regular Tax  AMT $953,702  Regular Tax $949,399  Pay the higher of the two  We just got reamed by the AMT

17 Comments on AMT  Example not up to tax law  Smaller corporations in fact are AMT exempt  (our hypothetical company was just small enough to be below actual tax threshold for AMT)  Individuals with taxable incomes over $58,750 need to calculate AMT  Two working professionals or even a single engineer can easily go over  AMT effecting large numbers of upper middle class tax payers  Originally intended as anti-millionaire threshold has not been indexed to inflation  Regular income taxes at lowest level since Great Depression

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