Alternative Minimum Tax - Back To Targeting the Very Rich

posted by Charley Mills - 2.20.18

The alternative minimum tax has been the bane of many middle-income taxpayers for some time. Nearly 50 years ago, the alternative minimum tax (AMT) was designed to impose a minimum tax on high-income taxpayers who were avoiding taxes by claiming legal deductions or other tax benefits—a mechanism that ensured some taxpayers didn’t escape income tax entirely. While Congress has talked about AMT reform, in the past we’ve only seen Congress kick the can down the road by raising the exemption amount every few years.

The Tax Cuts and Jobs Act made changes to medical deductions, state and local taxes, home mortgage interest, miscellaneous itemized deductions, personal exemptions, and standard deductions—some of which may have triggered AMT for the average taxpayer. Furthermore, the tax reform law increased AMT exemption amounts and significantly increased the income threshold at which exemptions phase out.

To start, all taxpayers must calculate their income tax liability the standard way. Then, taxpayers need to add some tax breaks and deductions back to their taxable income to determine AMT income. For example, take a household of a married couple filing jointly with four children. Using 2017 rules, they calculated their tax with an income of $310,000 and deductions of $42,000, which included $18,500 in state taxes, $2,500 in property taxes, $16,000 in mortgage interest, and $5,000 in charitable deductions. As a family of six, they were able to take $24,300 in personal exemptions. However, when they computed their AMT income, personal exemptions are eliminated, and they had to add back $18,500 of state and local taxes paid and $2,500 in property tax.

AMT Info graphic

AMT Infographic via

From AMT income, they subtracted the AMT exemptions based on filing status, and then applied the AMT tax rates to calculate their AMT tax liability. If the AMT tax liability is higher than the standard tax liability, the higher amount must be paid. In our example, AMT increased their overall tax liability by roughly $6,800.

Using 2018 laws, this family only has deductions of $31,000, because state and local taxes are combined with property taxes and are limited to $10,000, while personal exemptions have been eliminated. However, they gain a child tax credit of $8,000. Under the new tax reform law, their standard tax liability calculation is $47,539. For their 2018 AMT calculation, they only must add back the combined state and local taxes and property tax deduction.

In 2018, the AMT exemption amounts have increased to $70,300 for individuals and $109,400 for married filing jointly. These exemptions function similar to a standard deduction, shielding some of your income from tax by reducing your taxable income. AMT exemptions are considerably higher than the standard deductions because of all the deductions and tax breaks that must be added back to their taxable income under AMT rules. The phaseout thresholds were also substantially increased, meaning that the full AMT exemption can be taken by individual taxpayers who earn less than $500,000 or $1,000,000 for married taxpayers filing jointly. These changes result in a 2018 AMT calculation of $38,696—far less than their 2017 AMT calculation of $62,471. However, since they must pay the larger of the two tax calculations, their tax liability for 2018 would be $47,539.

With the larger standard deductions and limited itemized deductions that the Tax Cuts and Jobs Act enacted, fewer households should itemize, making them less likely to be affected by AMT. If you are subject to AMT, you may see your AMT calculations more closely resemble your standard tax liability calculations because of the changes to how your standard tax liability is calculated and the higher exemptions for AMT.
While Congress and President Trump did not repeal the alternative minimum tax for individuals, very few middle-income households should be subject to AMT over the next decade.

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a Certified Financial Planner™ professional.

EYE ON YOUR MONEY: Not All Business Tax Cuts Are Simple

posted by Charley Mills - 12.29.17

One of the key promises during President Trump’s campaign was to lower taxes for businesses from 35 percent to 15 percent and eliminate the corporate alternative minimum tax. The final version of the tax bill did eliminate the corporate alternative minimum tax, and lowered the tax for corporations to 21 percent in 2018. Furthermore, businesses organized as “pass-throughs” could get taxed at a less than 30 percent rate.

Taxes are never simple – despite the promise to simplify the tax code

Pass-through businesses are your LLCs, partnerships, S corporation, and sole proprietorships, in which the entity is not subject to income tax. Owners are taxed individually on the income, calculating tax on their share of the profits and losses. Because these business owners were at the mercy of their individual tax rates, some business owners could be taxed as much as 39.6 percent, not including the phase out of itemized deductions for high income earners.

In the finalized bill, pass-through businesses receive a 20 percent deduction of their qualified business income. Because taxes are never simple—despite the promise to simplify the tax code—the deduction is actually the lesser of: 20 percent of the taxpayer’s “qualified business income” or the greater of: 50 percent of the W-2 wages with respect to the business, or 25 percent of the W-2 wages with respect to the business plus 2.5 percent of the unadjusted basis of all qualified property.

OK, you want this in English. Qualified business income is income less ordinary deductions that you earn from a pass-through business, such as an LLC, sole-proprietorship, S corporation, or partnership. This does not include wages you earn as an employee. Let’s say you have an LLC (not a “specified service” trade or business), and your share of the qualified business income is $500,000. Multiply that by 20 percent and you get a deduction of $100,000. Woo hoo! Not so fast. There are limitations on the calculation that were added to prevent abuse of the rules.
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How does this work? Let’s look at the example of your LLC of which you only own 40 percent. The company produced $1.25 million in ordinary income. The company paid W-2 wages of $455,000 and holds $200,000 in property. Your allocation of the wages is $182,000 and 50 percent of that is $91,000. One more calculation: 25 percent of the W-2 wages with respect to the business plus 2.5 percent of the unadjusted basis of all qualified property—in our example, this comes to $47,500 ($45,500 + $2,000). You’ve got two numbers: $91,000 and $47,500. The greater of the two is $91,000. This is your income limitation. So, your deduction on your $500,000 qualified business income is now $91,000 versus the simple 20 percent. Mindboggling, isn’t it? And this example was highly simplified for your convenience.

Now, not every LLC is making $1.25 million. Lots of small businesses make around $125,000 a year. There is an exception for you! If your taxable income is less than $157,500 or $315,000 for married filing jointly, you should be able to ignore the W-2 income limitations.

To make things more complicated if you are part of a “specified service” trade or business you will be faced with a phase out.

Wait, what? Yes, “Any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.” Will be deemed to be a “specified Service”.

This means if your income is above $207,500 for individuals and $415,000 for joint filers you will not be eligible for the deduction. Welcome to simpler taxes.

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.

MAGA: Tax Changes That Affect the Kiddos

posted by Charley Mills - 2.06.18

While most individuals are taxed on their earned income at their own individual tax rates, unearned income is a very different beast—especially when it comes to a child’s unearned income. The Tax Cuts and Jobs Act made some significant changes in the way a child’s income is taxed.

Taxpayers often receive unearned income in the form of dividends or interest on investments, royalties, rents, and inheritances. In general, the IRS does not want parents to shift income-producing assets to a child under the age of 19 (or a full-time student under the age of 24), who is in a lower tax bracket. Enter the Kiddie Tax, where until Dec. 31, 2017, part of a child’s investment income was subject to tax at the parents’ top marginal income tax rate.

With the new tax laws, the first $2,100 is income tax-free because of the standard deduction

When a child, who can be claimed as a dependent by another taxpayer, only has unearned income, his or her standard deduction is $1,050. However, when a child also has earned income, the blended standard deduction becomes the greater of $1,050 or earned income plus $350, not to exceed the full standard deduction for an individual.

With the Tax Cuts and Jobs Act, a child’s unearned income in excess of $2,100 will be taxed at the rates that apply to trusts and estates—the parents’ top marginal tax rate won’t matter anymore. The first $2,550 is taxed at 10 percent, then investment earnings between $2,550 and $9,150 are taxed at 24 percent. The third bracket is from $9,150 to $12,500 and has a marginal rate of 35 percent. Anything above $12,500 will be taxed at 37 percent.

Now to put this in perspective, let’s say you have a custodial account for your child, holding McDonald’s stock, which pays about a 2.27 percent dividend yield. For your child’s unearned income to be taxed at 37%, the account would need to be more than $550,000! At McDonald’s current price, that’s well over 3,000 shares. For wealthy families, this change isn’t going to have a big impact. Chances are if your dependent child has more than half a million in invested assets it’s quite possible you too are in the 35 percent or 37 percent tax brackets, and you’re accustomed to having your child’s income taxed at your top rate.

Confused by the new tax laws?  You’re not alone.  Learn how Henssler can help

The new Kiddie Tax rates can affect middle-income families. Let’s say you and your spouse have taxable income of $135,000. Your child’s grandfather passes away and your child inherits a stock portfolio that generates around $5,500 in dividends a year. Under the 2017 rules, the first $1,050 of this was income tax-free. The next $1,050 was taxed at the child’s tax rate of 10 percent. That left $3,400 that was taxed at the parents’ top marginal rate of 25% for a total tax of $955 (($1,050 x 10%) + ($3,400 x 25%)).

With the new tax laws, the first $2,100 is income tax free because of the standard deduction. The next $2,550 will be taxed at 10 percent and the remaining $850 will be taxed at 24 percent for a total tax of $681 (($2,550 x 10%) + ($1,900 x 24%)).

In most cases, the Tax Cuts and Jobs Act’s Kiddie Tax rules will result in lower taxes; however, lower income parents who have children with substantial unearned income could see their child paying a higher tax rate because of the compressed trust and estate brackets.

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a Certified Financial Planner™ professional.

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