Dreaded AMT can constitute a tax break

For some already ensnared in the tax, Roth IRA conversions may be a plus

Apr 11, 2010 @ 12:01 am

By David Hoffman

Maybe it is just a sliver of a silver lining, but wealthy taxpayers subject to the alternative minimum tax may enjoy an edge in converting to Roth IRAs this year.

Where income from converting to a Roth individual retirement account could trigger the AMT's higher rates for many taxpayers, those already subject to the tax may be able to lock in relatively low tax rates on the conversion, said Susan Bruno, principal of Beacon Wealth Consulting LLC.

“I can actually use the AMT as my friend by accelerating income,” said Ms. Bruno, whose firm provides consulting services to high-net-worth individuals. “One of the best opportunities to do that is Roth conversions.”

The irony of actually saving money by using the AMT is a function of the complicated, controversial tax, which levies a 26% rate on the first $175,000 of AMT-eligible income and 28% on any excess income with exemptions that are phased out as income increases.

The phaseout ranges are $150,000 to $433,800 for married couples filing jointly, $112,500 to $299,300 for singles and $75,000 to $216,900 for married couples filing separately.

As a result of the phaseouts, the AMT marginal tax rates are actually 26%, 28%, 32.5% and 35%.

Taxpayers with income beyond the AMT phaseout range pay just 28% unless they are so wealthy that they fall into the 35% regular marginal tax rate. Taxpayers who haven't exhausted the exemption phaseout can bring in income at the 28% marginal rate — income such as that realized by a Roth IRA conversion, Ms. Bruno said.

And now is a particularly good time to do the conversion, she said, citing the rule change that eliminated the income eligibility ceiling.

By accelerating income via a Roth IRA conversion and locking in a 28% AMT rate, “I can take lemons and make lemonade,” Ms. Bruno said.

But it is a drink that can be shared only by a select few, said Robert Chapman, principal of Chapman & Co. CPAs.

“I don't think it comes into play as often as you would think,” he said.

It is much more common for taxpayers to try to avoid the AMT, or at least reduce their exposure to it, Mr. Chapman said.

Unfortunately, the AMT is set up in such a way that it is increasingly impossible for people to avoid it.

Originally intended as a way to prevent the wealthy from avoiding taxes, the AMT is encroaching on more and more middle-income taxpayers because it isn't indexed for inflation. As a result, according to experts, it has become the nation's parallel tax system, with its own definition of taxable income, exemptions and tax rates.

“I have a lot of individuals hit by [the] AMT, and there isn't anything they can do,” said William E. Hesch, president of an eponymous certified public accountant firm.

This year, the threat of the AMT is shaping the decisions of investors who are considering taking capital gains. Many adviser-client discussions have centered around whether it is better to take capital gains now at the present tax rate of 15% or in 2011, when the current rate will have expired and the new rate is likely to be 20% (InvestmentNews, March 15).

But any discussion about capital gains needs must include a look at how those gains will affect the investor's tax liability under the AMT, Mr. Hesch said. Since a capital gain is considered income, it can reduce or eliminate a taxpayer's AMT exemption, the effect of which may be to push the taxpayer into a higher tax rate, he said.

Luckily, there are some “bread and butter” techniques to which taxpayers can turn to reduce their exposure to the AMT, Mr. Chapman said.

For example, investors looking to reduce that exposure may want to weed out private-activity bonds from their investment portfolios, he said.

Such bonds can be troublesome because while the interest income they produce is fully exempt from regular federal income tax, it must be included when computing the AMT.

Taxpayers also can reduce their exposure to the AMT by “staggering” the payment of state and local taxes, which means making five quarterly payments in one year and three in the following year, said Harvey “Buz” Aaron, vice president and director of tax services at the wealth management unit of Braver PC, which manages $400 million in assets.

Since itemized deductions for state and local taxes reduce regular taxable income but are not deductible under the AMT, staggering state and local tax payments can reduce exposure to the AMT in alternate years, he said.

But such strategies aren't perfect, Mr. Aaron said.

The truth is, there just isn't much a taxpayer can do to get out from under the AMT, he said.

“It's incredibly frustrating,” Mr. Aaron said.

E-mail David Hoffman at -dhoffman@investmentnews.com.


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

May 02


Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in four cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video


The #MeToo movement and the financial advice industry

Attendees at the Women to Watch luncheon commend the #MeToo movement for raising awareness about the issue of sexual harassment and bringing women together.

Latest news & opinion

What the next market downturn means for small RIAs

Firms that have enjoyed AUM growth because of the runup in stocks may find it hard to adjust to declining revenues if the market suffers a major correction.

DOL fiduciary rule likely to live on despite appeals court loss

Future developments will hinge on whether the Labor Department continues the fight to remake the regulation its own way.

DOL fiduciary rule: Industry reacts to Fifth Circuit ruling

Groups on both sides of the fiduciary debate had plenty to say.

Fifth Circuit Court of Appeals vacates DOL fiduciary rule

In split decision, judges say agency exceeded authority.

UBS, after dumping the broker protocol, continues to see brokers come and go

The wirehouse has seen 14 individuals or teams leave and five join for a net loss of $2.4 billion in AUM


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print