By Sheryl Nance-Nash
While everybody has heard much about the "fiscal cliff," many people don't realize just how hard a hit they might take. The details are none too favorable. Take for example, the alternative minimum tax (AMT).
Right now some four million households pay AMT, which provides exclusions for certain kinds of income and deductions and credits for certain expenses. It attempts to ensure that an individual who benefits from certain exclusions, deductions, or credits pays at least a minimum amount of tax. The AMT applies to taxpayers above thresholds set by law.
In the past, Congress has enacted "patches" to index these income thresholds for inflation in order to prevent millions of taxpayers from being subject to the AMT. That safety net expired in December of last year. Congress has until December 31 to put in place a patch to prevent the AMT from expanding for the 2012 tax year.
"If Congress fails to act, more than thirty-one million taxpayers will be subject to AMT in 2012, totaling about $31 billion. This rounds out to about $4,200 per affected taxpayer, according to the Tax Policy Center's estimates," says Rosalind Sutch, a CPA with Drucker & Scaccetti.
Simply put, if Congress doesn't act, the ramifications are huge. "Every day that Congress fails to act, it becomes more likely that e-filing will indeed be delayed. Will it be late March? I hope not, but with the uncertainty we're facing, there will be some sort of delay. The length will depend on how long Congress takes to find some middle ground," says Sutch.
The impact of a delay in e-filling will be far reaching. "The administrative bottleneck that will occur for all taxpayers, including, and most especially, those who rely heavily on their tax refunds as a makeshift savings account, will delay refunds and hurt many American families," Sutch says.
Tax professionals will feel the pain too. "This is a nightmare. The tax software releases will be delayed, staff will be trained and ready to start preparing returns, while we all sit and wait for forms to be updated and released," says Sutch.
CPA Janet Lee Krochman says she has run a number of scenarios in the last month to determine the impact if Congress doesn't extend the patch by year-end. The most surprising was her twenty-something staff person who has been married for just over a year and whose husband is in college. They purposely left their 2012 W-4 withholdings at the higher single rate to force a larger refund to help with a move next year. "Imagine her surprise when she found out that $2,000 of that anticipated refund was going to AMT. Student loan interest is their only deduction besides the standard deduction and personal exemptions," says Lee Krochman.
How are accountants preparing their clients? Historically, Congress has passed the AMT fix, but with that a question mark for 2012 taxes, Chris Smith, CPA and owner of CB Smith & Associates, says if the AMT fix is passed, they'll continue to prepare tax projections using last year's statutory exemption amounts (which in 2011 was $74,450 for a married couple filing jointly). Additionally, they plan to send letters to clients along with new tax projections on December 15 (if there is no resolution at that point) that will explain what will happen to their tax liability if there is no AMT fix (which would revert back to the exemption of $45,000 for a married couple filing jointly). "I already told one client that if the AMT fix doesn't go through, he will owe an additional $8,000 in taxes."
For those who have never been subject to AMT, Sutch says her firm is projecting tax bills rising around $1,000 to $7,000. "We're reaching out to clients now so they can begin to save extra funds or start to plan for liquidating invested assets that may be required in order to fund what could be a significant new addition to their tax bill."
Smart strategies include (1) not further increasing any deductions that might not be allowed for AMT purposed; (2) not exercising any stock options where the deferral benefits might not be available; or (3) not recognizing large capital gains, where the realization of the gain itself is not an AMT preference item, but the potential increase in the state income tax deduction would be an AMT preference item, points out Mark Luscombe, principal analyst with CCH, a Wolters Kluwer business.
More specifically, Ken Kathcart, a CPA and partner with JLK Partners, says they're encouraging clients to prepay their January 2013 mortgage payment prior to December 21 to ensure that the interest payment is included on this year's year-end mortgage interest statement. They're also advising clients to take proactive action "to achieve the holy grail of tax planning - the AMT break-even point - where clients achieve the lowest possible tax rate while benefiting from the maximum allowable deductions."
What's the thinking about which way Congress will go? "Since the impact is so far reaching, it's much more likely Congress will move forward with one of two bills currently on the table. Over simplified, the only difference between the two bills is whether tax rates will increase for high-income households. Both would provide for similar patches to the AMT exemption," says Sutch.
While some see the debate spilling over until early next year, most are confident it will be resolved in 2012. Says Michael Specht, CPA, and member of Metis Group, "I do believe Congress will put in place the AMT patch prior to year-end."
Specht also expects that in the future, taxpayers will be less likely to be paying AMT. But while that seems like good news, it's not. Says Specht, "A taxpayer will pay the AMT when the AMT is greater than the taxpayer's regular tax rate. If the regular tax rates are increased or deductions are limited, as is likely under the current proposals, then the spread between the regular tax and AMT is increased, and it becomes more likely that the regular tax is greater than the AMT and fewer taxpayers are paying the AMT."