Article: AMT Credit Offers Taxpayers a Welcome Break

June 2007

AMT credit offers taxpayers a welcome break

New rule provides long-overdue relief for many people who deserve it ... and a windfall for some who don’t

Most discussions of the alternative minimum tax revolve around the necessity to pay more taxes, but this article offers some good news: Beginning with the 2007 tax year, certain taxpayers will be able to claim old, unrecovered AMT credit, even if it means getting a refund that exceeds the current year’s tax.

The new rule, which takes effect this year and continues through 2012, provides long-overdue relief for many people who deserve it, and a windfall for many people who don’t. Perhaps the most striking aspect of the rule is the poorly designed phase-out rule. Within certain ranges of income, people will face a marginal tax rate greater than 100% if their unrecovered credit is large enough.

Who Can Claim It? To claim this credit, you must have paid AMT in a previous year, and it has to be the right type of AMT. For example, you don’t get to claim a credit if your AMT liability was caused by a large number of exemptions or by a large itemized deduction for state and local taxes. The credit is allowed only for “timing items” – mainly, incentive stock options and, in fewer cases, accelerated depreciation. If you don’t have creditable AMT, the new rule won’t help you recover the tax.

When You Can Claim It. Many people assume that, if the AMT credit arises from exercising an incentive stock option, they can’t claim the credit until they sell the shares they acquired by exercising the option. That is not the case. Selling incentive stock option shares may help you claim a larger AMT credit, but you can claim the credit without selling shares. Under the general rule, you can claim the credit whenever your regular income tax is larger than the tax figured under the AMT rules. Under the new rule, you can claim the regular credit calculation or the new rule amount, whichever is higher.

The new rule applies only to “long-term unused minimum tax credit.” You can’t use it to recover a credit for AMT you paid last year or the year before. It allows recovery only if you have unrecovered credit from years that are more than three years earlier. The first year to which this provision applies is 2007 (i.e., returns to be filed in 2008), when you are potentially able to recover AMT paid for any year up to and including 2003 (i.e., returns filed in 2004).

How Old Is Your Credit? You will have to apply a first-in, first-out rule to determine the age of your credit. For example, suppose you paid $40,000 of creditable AMT for 2003 and another $50,000 for 2005. For 2006 you recovered $30,000 of credit under the normal rule. As of 2007, you have $60,000 in unrecovered AMT credit, but only $10,000 of that amount is eligible for recovery under the new rule. You have to apply your 2006 credit recovery against the credit you had available from 2003 – even if you recovered the credit by selling ISO stock you acquired in 2005.

Annual Limit. There’s an annual limit on the amount of old AMT credit you can claim in any year. The general rule (subject to the phase-out rule discussed later) is that you can recover 20% of the old AMT credit each year. For example, if you have $80,000 of old AMT credit in 2007, you can recover $16,000 for that year. However, if your old AMT credit is less than $25,000, you can claim $5,000 or the full amount of the credit, whichever is less. For example, if your unrecovered credit is $12,000, you can recover $5,000 per year the first two years and $2,000 in the third year.

Credit Is Refundable. The main reason this relief provision is such a big deal is that it’s refundable. Thus, you can claim a refund that exceeds the amount of tax you paid through withholding or estimated tax payments. This provision can put a lot of money in your pocket if you have a large amount of old AMT credit.

Example: You earn about $120,000 per year and have $22,000 in income tax withholding, which is roughly equal to the amount of tax you would otherwise owe. You also have $1 million in old AMT credit from a stock option you exercised in 2000. You’ve been recovering about $1,500 of the AMT credit each year, which is better than nothing but doesn’t put much of a dent in the $1 million. On your 2007 return you can claim 20% of that credit, and Uncle Sam will send you a refund check of about $200,000.

Phase-Out Rule. The bad news is that relief under this rule is phased out over the same range of income currently used to phase out personal exemptions. While this rule has enormous and complicated consequences, the rule itself is fairly simple. It provides that the amount of credit you can claim in any year is phased out over the same income range used to phase out personal exemptions. For 2007, those ranges are as follows:

Filing Status	Begin	End
Married joint	$234,600	$357,100
Single	$156,400	$278,900

Because this phase-out has mind-boggling implications that vary from taxpayer to taxpayer, you should check with your Schmidt Westergard & Company tax professional to learn how it applies to your situation and to develop a plan for maximizing your refund.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.