Alternative Minimum Tax Planning - Importance of Differing Types of Income

As noted in the last article, the tax brackets that apply to capital gains and dividends are completely different from the tax brackets that apply to ordinary income . By definition, all income other than capital gains and dividends is called ordinary income.

Unlike ordinary income, the tax brackets for capital gains and dividends are the same for the Regular Tax as they are for the on Alternative Minimum Tax . This was an attempt by Congress to keep taxpayers from having to pay the AMT on this income, by more or less carving it out of the AMT computation.

Unfortunately, there are other variables in the mechanics of the AMT that offset this capital gains and dividends rate benefit. The primary one is due to the impact of capital gains and dividends on the AMT exemption amount, because the AMT exemption is phased out as your income increases.

The AMT exemptions vary, depending on your filing status. The amounts for 2009 are:

$70,950 - married filing jointly
$46,700 - single taxpayers
$35,475 - married filing separately

Here's what causes the problem: if you have capital gains or dividends, they are included in your Adjusted Gross Income ("AGI"), and, accordingly, they also are included in your Alternative Minimum Taxable Income ("AMTI"). As you can see by looking at the schedule in your tax return, the exemption phase-out is based on AMTI. What does this mean?

To illustrate, assume you have an additional $10,000 of capital gains. If you just compared the tax rate schedules for the AMT and the Regular Tax, you would conclude that this would have no impact on your AMT because it will be taxed at the same rate under both computations. But here's what actually happens from adding $10,000 to your
AGI:

(a) AGI increase - $10,000

(b) AMT Exemption Phase-Out (25%) - $2,500

(c) Effective increase in AMT-(a) + (b) - $12,500

If you are in the 28% AMT bracket, you would pay an additional $700 (again, as discussed above, this will vary due to the several Regular Tax and AMT limitations) from having this supposedly AMT-neutral additional $10,000 of capital gain income.

The types of income individuals may have can vary significantly, depending on whether they find themselves in one or more classifications of taxpayer: Investors, Employees, Self-Employed Individuals, or Retirees. Future articles will take a closer look at each of these classifications.


George Bauernfeind is with AMT Individual - providing information on Alternative Minimum Tax Planning . He writes articles to help the tax payers to pay less Alternative Minimum Tax. He recommend to use Alternative Minimum Tax Calculator to reduce Alternative Minimum Tax.