Solutions Chapter 15 - Describe the purpose of the...

Info iconThis preview shows pages 1–7. Sign up to view the full content.

View Full Document Right Arrow Icon
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 4
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 6
Background image of page 7
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Describe the purpose of the alternative minimum tax. The alternative minimum tax (AMT), like the passive activity rules, was enacted in 1986 to curb perceived abuses by high—income taxpayers to minimize their current income tax liability. The AMT is designed primarily to change the timing of tax payments, although in some cases, imposition of the AMT results in a permanent increase in tax. Describe, in general, how the AMT is calculated. To calculate the AMT, the taxpayer will start with his or her taxable income From the Form 1040, and will make certain changes to that number based on AMT adjustments and preferences. How do adjustments and preferences affect AMTI? Adjustments can either increase or reduce alternative minimum taxable Income (AMTI), while preferences always resuit in an addition to AMTI. How is the AMT exemption phased out? To the extent that AMTI exceeds certain amounts, the exemptions begin to phaseout. The phaseout rule states that the exemption amount is reduced by 25% of the amount by which AMTI exceeds the phaseout threshold.Therefore, high income taxpayers, therefore, may have their AMT exemption limited, or may not be able to use any exemption in the calculation of their alternative minimum tax. 141 L < i i i i a i 5 l i . 10. 11. 12. What is the difference between an exclusion item and a deferral item? Adjustments and preferences are classified as either exclusion items, or deferral items. Exclusion items result in a permanent increase in tax. Deferral items result in a tax credit equal to the additional tax that must be paid in the current year, and this credit can be used to offset tax liability in a future year when the taxpayer is no longer subiect to the AMT. There is an unlimited carry—forward for the AMT credit generated from deferral items, but the credit may not be carried back and applied against regular tax liability in past years. From a planning standpoint, there— fore, deferral items are the better AMT preferences and adjustments to have. What itemized deduction items are lost by the application of the AMT? ° Home mortgage interest on excess refinancing. - An additional 2.5% of medical and dental expenses. ‘ State and local income, property, and sales taxes. " Most miscellaneous itemized deductions. How is qualified mortgage interest affected by the AMT? Generally, qualified mortgage interest paid to acquire a primary and secondary residence is deductible for both reg— ular and AMT tax purposes. if, however, the mortgage is refinanced in an amount in excess of the original mort- gage, interest on the excess refinancing (Current Mortgage — amortized original mortgage), must be added back to income to calculate AMTI. In addition, this is an exclusion item. What regular tax itemized deductions are not affected by AMT? Charitable contributions and casualty losses are not impacted in any way by AMT rules, and they do not have to be added back into income (or, an alternative way of thinking of this is reversed out) when calculating AMTI. How are private activity municipal bonds affected by AMT? _ The add-back of the interest on private activity municipal bonds, and the deduCtion permitted for investment interest incurred to acquire those bonds, are considered to be AMT exclusion items. As a result, any increase in tax caused by the adjustments for private activity bonds will be a permanent increase in tax for the taxpayer, and no credit will be available to offset future regular tax liability. The interest on certain private activity municipal bonds issued after June 30, 2008 are not considered preference items, and will not trigger the payment of an AMT. How does the exercise of an ISO impact AMT? While the exercise of an incentive stock option (ISO) does not impact the taxpayer’s regular tax liability, it may result in the imposition of AMT. The difference between the value of the stock on the date of exercise and the strike price of the option must be added to taxable income to arrive at AMTI. When a taxpayer exercises a large number of options in one tax year, and does not sell the stock (thereby triggering a disqualifying disposition and imposing ordinary income tax on the gain), there is a danger of becoming an AMT taxpayer. Name three businesswrelated items that can be affected by AMT. Depreciation, depletion, and qualified small business stock under Section 1202. Are all corporations subject to AMT? No, since 1997, small corporations have been exempted from the AMT. A small corporation is defined as a corpo— ration with average gross receipts of $5 million or less for the past three taxable years. Once a small corporation achieves exemption from the AMT by meeting this rule, it remains exempt as long as its three—year average gross receipts do not exceed $7.5 million. Once three-year average gross receipts exceed $7.5 million, the corporation is subject to the corporate AMT. " " "C‘Hiifiiéfi' "1'53 " ‘Tiiiémii'iréfiiifiliié Ml'n'iiibii Tax ‘ ' HHI—l Company grants Henry one incentive stock option (ISO) on January 10, 2007. The exercise price is $10. The market price on the exercise date (January 11, 2003) is $335. What is the AMT consequence when Henry exercises the ISO? a. $0 AMT gain. b. $10 AMT gain. c. $23 AMT gain. (1. $33 AMT gain. The correct answer is c. The AMT gain is the difference between the market price and the exercise price at the date of exercise. $33 - $10 = $23 Which of the follOWing is true regarding AMT? a. Interest for home acquisition indebtedness deducted for regular tax purposes must be added back. b. A taxpayer who has deductible medical expenses for regular tax purposes of $10,000 will have an add- back of 2.5% ofAGl for AMT purposes. c. Municipal bond interest must be added back for ANlT purposes. d. Charitable contributions deducted for regular income tax purposes are limited to 30%. The correct answer is b. . Medical expenses are allowed in amounts over 7.5% ofAGI. For AMT purposes, they are allowed in amounts over 10% OFAGI, thus a 2.5% oFAGI add back will occur. Interest deducted for home acquisition indebtedness is not an add-back for AMT; however, it is if the loan is a home equity loan. Charitable contributions are not added back for AMT purposes. Municipal bonds in general are not added back for AMT purposes, however, private activity bonds are. Your client, who has a taxable income of $200,000, is concerned about being subject to the alternative minimum tax (AMT). The following income and deductions were included in computing taxable income. Select the one item that may be added to (or subtracted from) regular taxable income in calculating the AMT. a. A long—term capital gain of $90,000. b. A cash contribution to your client’s church of $18,000. c. Dividend income of$80,000. d. A state income tax deduction of $22,000. The correct answer is cl. Option d is correct because no taxes are deductible for AMT purposes. Options a, b, and c are included for both regular and AMT purposes. .. .. gas. 4. Gavin, a single individual who is an executive at IT Consulting, Inc. was granted 1,500 ISOs on IT’S stock two years ago when the price per share was $25. The last few years have resulted in tremendous growth for IT Consulting and the stock is now trading at $55 per share. Gavin exercised the 1505, but did not sell the stock — he plans on holding the shares for at least a year so he can pay the lower capital gains tax rate on the growth. How much will Gavin have to add to his taxable income when computing AMTI as a result of this transaction? a. $0. b. $37,500. c. $45,000. d. $32,500. The correct answer is c. Even though exercise of the options results in no taxable event for regular tax purposes this year, Gavin will have to add $45,000 [($55 — $25) x 1,500] to his taxable income when computing AMTI. If there are no other trans- actions this year that could reduce AMTI, it is likely that Gavin will become an AMT taxpayer for the year, since the tax preference item w the gain on the exercise of the ISO 7 is greater than his exemption for AMT purposes. 5. The alternative minimum tax (AMT) was originally designed to: a. Create a more user—friendly tax system. b. Curb abuses by high—income taxpayers. c. Provide additional credits to certain low—income taxpayers. (1. Give taxpayers a choice of which tax to pay. The correct answer is b. The AMT was enacted in 1986 to curb perceived abuses by high—income taxpayers trying to minimize their cur- rent income tax liability. I 6. In 2009, Larry (a single taxpayer) has an AMTI of $175,000. What is Larry’s AMT exemption this year? a. $0. b. $15,625. c. $31,075. d. $33,750. The correct answer is c. Because Larry’s AMTI is above the AMT Phaseout threshold amount, his AMT exemption must be reduced. Larry’s exemption is reduced by 25% of the amount that his AMTI exceeds $112,500 (the threshold). Therefore, Larry’s exemption must be reduced by $15,625 [($ 175,000 v $1 12,500) x 0.25]. As a result, Larry is entitled to an exemption of $51,075 ($46,700 — $15,625). "1'44"""‘CHAt’iEfi'igi'"fills‘ALtEHNA‘tIvé"MiNIMU'M ' " 7. In 2009, Elizabeth (a surviving spouse) has an AMTI of $450,000. What is Elizabeth’s AMT exemption this year? a. $0. b. $45,000. C. $15 0,000. cl. $35 0,000. The correct answer is 9.. Elizabeth is not entitled to an AMT exemption this year because her AMT exemption has been reduced to zero. Because Elizabeth’s AMTI is above the AMT phaseout threshold amount, her AMT exemption must be reduced. Elizabeth’s exemption is reduced by 25% of the amount that her AMTI exceeds $150,000 (the threshold). There- fore, Elizabeth’s exemption must be reduced by $75,000 “$450,000 - $150,000) x 0.25]. However, the amount of the exemption is only $70,950. Therefore, Elizabeth is not entitled to an AMT exemption this year. George has deductible medical expenses of $12,000 under the regular tax system and an AGI of $100,000. What are the tax consequences for computing George’s AMT I ? a. George’s AMTI is not affected by his medical expenses. b. $300 ofGeorge’s medical expenses must be added back to compute his AMTI. c. $2,500 of George’s medical expenses must be added back to compute his AMTI. d. All of George’s medical expenses must be dedueted to compute his AMTI. The correct answer is c. Medical and dental expenses are deductible for AMT purposes only to the extent that they exceed 10% of the tax— payer’s adjusted gross income. Therefore, $2,500 (or 2.5% of George’s AGI of $100,000) must be added back to compute his AMTI. Which of the following deductions would be Fully allowed in calculating a taxpayer’s AMT? a. Interesr on a mortgage with a principal balance of $500,000. The mortgage was originally taken out for $400,000, and was almost immediately refinanced to acquire $100,000 in home equity. b. Medical expenses in excess of 7.5% of AGI. 'c. Real estate taxes paid on the taxpayer’s principal residence. (:1. Casualty iosses in excess of 10% ofAGI. The correct answer is d. While deductible for regular tax purposes, the interest on the $500,000 mortgage must be reduced by the percent— age that represents financing ab0ve the original mortgage, which in this case is $100,000. Medical expenses in excess of 10% oFAGl, not 7.5%, are deductible for AMT purposes. State and local taxes are not deductible once a taxpayer becomes an AMT taxpayer, but casualty losses may be claimed following the same rules that apply for reg- ular tax purposes. ' ' "1313' 10. Which of the following would be added to a taxpayer’s regular taxable income to arrive at alternative minimum 11. taxable income? a. Receipt of interest on public purpose municipal bonds. b. Receipt of interest on private activity municipal bonds. (1. Exercise of non—qualified stock options. d. Sale of the shares purchased through the exercise of incentive stock options. The correct answer is b. While private activity municipal bonds generate interest that is exempt for regular income tax purposes, once a tax— payer is subject to the AMT, the interest generated by these bonds is taxable, and must be added to alternative minimum taxable income. The interest earned on public purpose municipal bonds is always exempt from tax under the regular or AMT system. The exercise of a non—qualified stock option will generate ordinary income which is taxed for regular income tax purposes, but would not have to be added back to calculate AMTI. The sale of shares purchased through the exercise of incentive stock options generates a negative adjustment to AMTI. Which of the following statements concerning the taxation of incentive stock options (ISOs) is correct? a. On the date of exercise, the difference between the fair market value of the stock and the exercise price is included in regular taxable income. b. If the taxpayer sells the stock acquired by exercising an ISO more than one year after the date the option was granted, the gain will be taxed at capital gains tax rates. c. The sale of stock acquired by exercising an ISO will trigger a potential AMT tax for the taxpayer. d. The grant of 1505 to a taxpayer does not result in a taxable event for regular or AMT tax purposes. The correct answer is d. When an ISO is exercised, there is no regular tax consequence, but the difference between the fair market value on the date of exercise and the strike price becomes an AMT preference. In order to achieve capital gains treatment on the exercise of an ISO, the taxpayer must hold the stock 2 years from the date of the grant and one year from the date of exercise, making option B incorrect. Option C is incorrect since it is the exercise of the option, not the sale of the stock, that triggers a potential AMT tax. Since 1805 must be issued with a strike price equal to fair market value on the date of the grant, they will never create a taxable event on issuance. 12. John became an AMT taxpayer last year. As a result, he had to add several items to his taxable income in arriving at alternative minimum taxable income. Which of the following items will result in an AMT credit that can be used to offset future regular tax liability? a. $7,000 in property taxes paid on his principal residence. b. $80,000 difference between the fair market value of stock and the strike price in the incentive stock option used to purchase the stock. c. $3,000 in interest on private activity municipal bonds. d. $2,000 in additional medical expenses. The correct answer is b. The inclusion of the difference between the fair market value and exercise price of the stock options will result in a credit that John can use against fixture regular income tax liability. The other items are adjustments made to his itemized deductions, which result in permanent differences in tax liability as a result of the imposition of the AMT. 1 46 " ' " earner TS? " 'T'H'e"'i¥i_'tEfiiiiifive" MI i\i iiiiii ii tar ' " ' " ' ' " ' 13. Which of the following statements concerning the application of the AMT to C corporations is correct? 14. 15. a. As separate taxable entities, all C corporations are potentially subject to the AMT. The AMT tax rate that applies to corporations is a flat 26%. c. Corporations that have average gross receipts of $7.5 million or less on a rolling three-year average are exempt from the AMT. d. All corporations are exempt from the AMT, since the AMT applies only to individuals. ThC correct answer is C. In 1997, Congress created an exemption for small businesses so that they do not have to be concerned with the imposition of an AMT. Businesses that do nor meet the exemption requirement (average gross receipts of less than 7.5 million on a three year rolling basis), are subject to AMT and pay a flat rate of 20%. All of the following adjustments or preferences will result in a permanent increase in tax when a taxpayer becomes an AMT taxpayer EXCEPT: a. Most miscellaneous itemized deductions. b. Medical expenses in excess of7.5% and less than 10% ofAGI. c. State income taxes. d. The gain on stock underlying ISOs from the date of grant to the date of exercise. The correct answer is d. The inclusion of the gain on 1805 from date of grant to date of exercise creates a credit that can be used against future regular income tax liability. All of the itemized deduction adjustments result in a permanent increase in tax liability when a taxpayer falls into the AMT system. i All of the following statements about the alternative minimum tax (AMT) are correct, EXCEPT: a. The AMT is designed primarily to change the timing oftax payments to more current. b. Some adjustments made for AMT purposes result in a permanent increase in tax. c. As an alternative to the regular income tax system, a taxpayer may elect to pay tax based on the AMT calculation. (1. The AMT frustrates efforts by taxpayers to participate in activities that reduce or eliminate their current tax liability. The correct answer is c. if the calculated tax due is greater under the AMT, the taxpayer must pay the higher amount. The AMT is not a voluntary alternative to the regular tax system. It is a mandatory alternative, and applies only when the AMT tax exceeds the regular tax imposed on the taxpayer. 1'4? ...
View Full Document

This note was uploaded on 02/21/2011 for the course ACCT 3410 taught by Professor Vicky during the Spring '11 term at Aarhus Universitet, Aarhus.

Page1 / 7

Solutions Chapter 15 - Describe the purpose of the...

This preview shows document pages 1 - 7. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online