Tom Martin
[Editor's Note: This is a guest post from Tom Martin, CFP®, CPWA®, AIF® and Eric Meyer. Tom is one of the authors of Doctors Eyes Only and an executive with Larson Financial Group LLC. He has guest posted here before. Eric is an accountant and the executive director of MedTax, which partners with Larson. I wrote recently about the AMT, but it is such an increasingly important topic for docs, it never hurts to hit it again from a different perspective. I have no financial relationship with either author. Like every other post on this blog, this one is for educational purposes and does not constitute tax, legal, or accounting advice. Eric is an accountant, but he isn't YOUR accountant. Tom is a financial planner, but he's not YOUR financial planner.]
Eric Meyer
Each year, more and more physicians find themselves subject to the Alternative Minimum Tax (AMT). When asked, many don’t know how they got there or what, if anything, they can do about it.
The first year I owed AMT caught me by surprise. I’d run through tax projections with my accountant at quarterly intervals throughout the year. Why were our projections off by more than $10,000? Why are many physicians paying between $5,000 and $15,000 per year in taxes that they do not owe under our normal tax system? Enter the AMT.
This brief post will educate you on the AMT, some common triggering pitfalls for physicians, and finally, what might be done to minimize its impact on your taxes.
What is the AMT?
The alternative minimum tax was instituted back in 1969 when 155 American families earning more than $1 million owed $0 in federal income tax. This was due to the way deductions were established at the time. Congress didn’t think these families were paying their fair share. Instead of changing the tax code for everyone, they decided to institute an entirely new tax structure to bring these families back into the tax-paying fold.
In its most basic form, the AMT is a totally separate way of calculating how much you owe in taxes. By examining line 45 of your personal tax return (2011 Form 1040), you’ll quickly see if you have been historically falling under this other tax structure. To simplify, think of AMT as a flat tax rate of approximately 28%. This is different than the effective and marginal tax rates you’ve already learned about on this blog. Under AMT, there are only two marginal brackets—a 26% bracket and a 28% bracket. The 28% bracket kicks in after $175,000 of income.
What causes you to be subject to AMT?
You’re subject to the AMT because you are eligible for deductions under our normal tax system that Congress has deemed inappropriate for the AMT system. Some deductions are safe under AMT, and don’t hurt you, while other deductions are not and can. Because of this, it’s not easy to look at someone’s income and know in advance if they will or will not be subject to AMT. A general rule of thumb is that you are more likely to be subject to AMT if your income is between $250,000 and $500,000 per year, but several families with incomes in excess of $1 million per year still owe AMT.
What deductions are typically safe under the AMT?
- Charitable contributions
- Mortgage interest for your personal residence (note the home equity loan exception below)
- Deductions for your business taken on Schedule C or through your LLC or S-Corp
- Retirement plan contributions
What deductions or tax-advantaged issues can commonly cause a physician to be subject to the AMT?
- Property taxes
- State and local taxes
- Mortgage interest for certain home equity loans
- Unreimbursed business expenses deducted on Schedule A
- Professional fees deducted on Schedule A (including legal and investment advisory fees)
- Realization of long-term capital gains
- Interest from certain municipal bonds deemed “private activity bonds”
- The exercise of incentive stock options (provided by an employer)
- Use of the standard deduction
What are some ways to potentially reduce exposure to the AMT?
- Claim itemized deductions even if smaller than the standard deduction.
- Ask for a larger expense reimbursement account from your employer in exchange for a smaller salary.
- Increase contributions to retirement plans offered by your employer.
- Use a dependent care reimbursement arrangement through your employer to deduct your childcare expenses rather than claiming these deductions on your tax return.
- Consider timing state, local, and property tax payments to bundle them into an every-other-year payment structure.
- Reduce exposure to private activity municipal bonds.
- Have your investment advisor bill fees to your IRAs or 401(k) rather than your taxable (non-qualified) account. (if you fall under AMT, then you are not able to deduct investment advisory or other professional fees even if they exceed the 2% threshold)
- Consider converting traditional IRA funds to Roth IRA funds if you are comfortable with a 28% tax rate.
Each situation is unique. Even if you find you owe AMT, there may be ways to reduce or eliminate it. We advocate that physicians should have their accountant run a year-end tax projection each November. This way they can see if AMT is an issue and seek to reduce exposure if possible.
Could someone elaborate on #5? If I switch to an every-other-year payment structure but still pay AMT both years, does it still benefit me? Or is the benefit only realized if switching to this pay structure makes it so I pay AMT only every other year? I am just not understanding how this is of benefit.
Alan-
I think you’ve got it. The every other year idea is that you only get hit with AMT every other year. A lot of people do the same thing with the regular tax system, only they take the standard deduction every other year, and bunch their itemized deductions for the other years.
Hi Alan,
Whitecoat is right on the money. #5 helps most if it kicks you out of AMT every other year.
If you’re still in AMT both years, it’s not likely doing much unless it is helping you adjust the AMT phase outs. The way to check is to run your average tax with bundling every other year compared to not bundling those items. There could still be a benefit if it lowers your average tax rate factoring in the AMT. Although their are two AMT brackets (with the highest at 28%), it’s a bit misleading because if you fall under a certain range of phase outs, you could actually be paying a higher average rate even though you’re getting hit with AMT. In other words, we have some physicians at a 30%+ average tax rate even after they enter AMT because of where they fall on the phase outs. The only real way to check the benefit is to run the strategy and then check the change to your average tax rate (as a whole). Then you’ll see if there’s a benefit or not in your situation.
Hope that helps. The great news is that since you were already getting hit with AMT, this recent tax change should have much less of an impact on you compared to many other physicians.
I appreciate the continued flow of highly relevant information. I had one question about one of your points. How does claiming itemized deductions even if less than the standard deduction help you to avoid the AMT? Any clarification is greatly appreciated. Thanks again for the continued support.
Hi Andrew,
The standard deduction isn’t allowed under the AMT but many itemized deductions are still allowed. For example, if your mortgage interest and others are smaller than the standard deduction, then you would completely lose them if you fell into AMT and claimed the standard deduction. However, if you itemize (even though less than the standard deduction) then you would likely get some added benefit of the itemized deductions that don’t get eliminated by the AMT.
Hope that makes sense. Lots of good info out there if you google “AMT Standard Deduction”.
Just as a reminder – I don’t claim to be a tax expert. My advanced tax training was done at Chicago Booth but I rely on Eric and his team to actually run the numbers and keep me up to speed. In other words, talk with your accountant before you take any action. Thanks Andrew!
Tom,
Thanks for your clarification. I guess one option is to use tax software and then compare the bottom line when using itemized vs. standard deduction? Thanks again.
Andy
So appreciated this article. We just discovered we’re paying AMT for 2012 today. It was a shock, to say the least. Had no clue it was coming. I had a question on the “every-other-year payment structure” for state or property. How does one go about setting that up?
Tim
Many expenses can be bundled into a prior year. You can often make an early mortgage payment or two. Those who make large annual charitable contributions can make one year’s contribution on Jan 1st and the next one on December 31st, effectively bunching them. I could do that with my state income taxes also since my state doesn’t require quarterly estimated payments. I could pay 2012’s tax in April 2013 and 2013’s tax in December 2013. Property tax might be a little trickier, but I suppose you could probably pre-pay that. You could also pay late and just pay the penalties and interest if they’re less than the tax benefit of doing so. There are lots of ways to bunch expenses if it helps your situation. It’s usually done by people who take the standard deduction one year and itemize the next. But I suppose you can apply the same principle to the AMT.
Very nice post. I absolutely appreciate this site.
Thanks!
[Comment edited in 6 of the 7 places it was placed on my website. The original was left up on the Larson Review post. Christopher- I’m sorry you had a terrible experience and obviously feel a need to warn other doctors about your bad experience. I would caution you on two points:
#1- Don’t spam my website or I’ll just block your IP address. Don’t place the comment on a half dozen different posts nor in multiple places on the same post.
#2- Keep things factual. If you stick to the facts and clearly identify your opinions and feelings, you’ll keep both of us out of trouble with regards to libel laws. Larson in particular takes these sorts of comments very seriously.]