Alternative Minimum Tax – AMT and Unexpected Investment Income

28 Nov Alternative Minimum Tax – AMT and Unexpected Investment Income

It is no secret that the US Congress’ growing inability to agree on matters of substance is both disturbing and frustrating. The Alternative Minimum Tax (AMT) problem of not automatically adjusting for inflation is yet another example of the collective ineptitude of our elected officials. Without a comprehensive solution this FLAT TAX will eventually hit the majority of US Taxpayers.  In the mean time however I must say it is cathartic how it is gradually and consistently affecting more and more taxpayers every year.

Here is just one example. I have a retired client who paid AMT for the first time this year and quite literally it almost killed him. He carefully built up a reasonable savings with a typical balanced portfolio of mutual fund investments. He reinvested income and capital gains that the mutual funds reported into additional shares. Surprisingly one mutual fund he owned made an unusually large and unexpected year-end capital gain distribution that pushed his income into the AMT zone which caused him to pay the IRS a lot more than he planned. After declaring the capital gain and automatically reinvesting the capital gain into additional shares of the mutual fund the value of the mutual fund shares substantially decreased. So even though he is expected to realize a large capital gain for tax purposes, because the share price of the mutual fund dropped so precipitously there was relatively little left after liquidation to pay the tax liability incurred when the liability was due. His story is relatively common. Most people don’t realize how easily investment income, particularly investment income that is unplanned or unexpected, can trigger the AMT.

Yes it is true that capital gains do NOT directly affect AMT and they’re not treated any differently than they are with the regular income tax. The problem however is with the AMT exemption amount, this is the amount Congress has to temporarily boost each year to keep millions more people from falling victim to the AMT. The exemption starts to phase out at a certain income level. In 2009, the exemption phase-out for married couples filing jointly began at $70,951.

In my client’s situation large unexpected capital gains lead to higher gross income pushing my client’s adjusted gross income above the thresh hold AMT exemption amount. One prospective solution could have been to sell loosing investments to realize some capital losses to offset some of the gains. The trick however is knowing whether the gains will affect your AMT, and if so, whether it’s better to realize them this year or next.

When it comes to AMT it seems to be all about the tax planning. This might sound like a ‘limousine problem’ but when you are retired and living on a fixed income it can really impact your quality of life.