CHAPTER 12 ALTERNATIVE MINIMUM TAX SOLUTIONS TO PROBLEM MATERIALS. 1 AMT purpose Unchanged 1 2 AMTI: direct versus indirect calculation

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CHAPTER 12

ALTERNATIVE MINIMUM TAX SOLUTIONS TO PROBLEM MATERIALS

Question/ Problem Topic Status: Present Edition Q/P in Prior Edition

1 AMT purpose Unchanged 1

2 AMTI: direct versus indirect calculation

approach

Unchanged 2

3 AMT adjustments versus tax preferences Unchanged 3

4 Tax preferences Unchanged 4

5 Tax preferences Unchanged 5

6 AMT formula Unchanged 6

7 Regular income tax liability versus AMT Unchanged 7

8 AMT exemption amount Unchanged 8

9 AMT rates Unchanged 9

10 AMT and nonrefundable tax credits New

11 AMT adjustment for cost recovery on personalty Unchanged 11

12 AMT adjustment for mining exploration and

development costs

Unchanged 12

13 AMT adjustment for mining exploration and

development costs

Unchanged 13

14 Long-term contract income adjustment Unchanged 14

15 Incentive stock options adjustment New

16 Regular income tax adjusted basis versus

AMT adjusted basis

Modified 16

17 Regular income tax adjusted basis versus

AMT adjusted basis

Unchanged 17

18 Passive activity losses AMT adjustment Unchanged 18

19 ATNOLD Unchanged 19

20 AMT and itemized deductions Unchanged 20

21 AMT and itemized deductions Unchanged 21

22 AMT cutback adjustment Unchanged 22

23 AMT and interest Unchanged 23

24 AMT and personal and dependency

exemp-tions and standard deduction

Unchanged 24

25 Percentage depletion preference Unchanged 25

26 Private activity bond and interest as preference Unchanged 26

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Question/ Problem Topic Status: Present Edition Q/P in Prior Edition

27 Purpose of AMT credit Unchanged 27

28 Corporate AMT Unchanged 28

29 ACE adjustment New

30 AMT planning on recognition of income New

* 31 AMT base Modified 31

* 32 AMT calculation Modified 32

* 33 AMT calculation Unchanged 33

* 34 AMT exemption amount Unchanged 34

* 35 AMT and nonrefundable credits Unchanged 35

36 AMT adjustments: circulation expenditures Modified 36

* 37 Adjustments for circulation expenditures Unchanged 37

* 38 Cost recovery adjustment for AMT: realty New

39 Cost recovery adjustment for AMT: personalty Unchanged 39

40 Mining and exploration costs adjustment Unchanged 40

* 41 AMT adjustment for long-term contract Unchanged 41

* 42 Incentive stock option adjustment Unchanged 42

* 43 Adjustments for incentive stock options Unchanged 43

* 44 AMT adjustments: adjusted gain or loss Modified 44

45 Computing AMT passive loss Unchanged 45

46 Itemized deductions adjustment for AMT and

medical expenses

Unchanged 46

* 47 AMT adjustments for itemized deductions Modified 47

* 48 Mortgage interest adjustment for AMT Unchanged 48

49 Adjustment for investment interest and private

activity bond preference

Unchanged 49

* 50 Itemized deductions adjustment for AMT Unchanged 50

51 AMT standard deduction and personal

exemption adjustments

Modified 51

52 AMT percentage depletion preference Unchanged 52

* 53 AMT IDC preference Unchanged 53

54 Tax preference items and AMT adjustments

including private activity bonds

Unchanged 54

* 55 Comprehensive AMT calculation Unchanged 55

* 56 AMT calculation Modified 56

* 57 Computation of taxable income and AMT Unchanged 57

* 58 Computation of taxable income and AMT New

* 59 AMT tax credit carryover Unchanged 59

* 60 Exemption from corporate AMT for small

corporations

Modified 60

* 61 ACE adjustment Unchanged 61

* 62 Corporate AMT Unchanged 62

* 63 Corporate AMT Unchanged 63

* 64 Cumulative Modified 65

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Research Problem Topic Status: Present Edition Q/P in Prior Edition

1 Cooperative housing corporation and real

estate taxes

Unchanged 1

2 AMT and itemized deductions versus the

standard deduction

New

3 AMT and Form 6251 Unchanged 3

4 AMT and tax benefit rule Unchanged 4

5 Internet activity Unchanged 5

6 Internet activity Unchanged 6

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CHECK FIGURES 31. $244,125. 32.a. $32,373. 32.b. $67,305. 33. Case 1: MFJ $36,999; single $30,389. Case 2: MFJ $17,999; single $11,389. 34. Case 1: Single $28,375; MFJ $55,500; MFS $7,750. Case 2: Single $5,875; MFJ $33,000; MFS $0. Case 3: Single $0; MFJ $0; MFS $0. 35.a. $0. 35.b. $78,000. 36. Expensing saves $37,172; amortizing saves $42,840. 37. 2006 positive $100,000; 2007 positive $10,000.

38.a. $8,520 positive adjustment.

38.b. $0 adjustment.

39.a. $15,000 positive.

39.b. Elect 150% DB method.

40.a. $540,000 positive adjustment for

2006.

40.b. Amortize expenditures over 10 years.

41. $120,000 positive adjustment for

2006; $120,000 negative adjustment for 2007.

42.a. No reporting required in 2006.

42.b. No reporting required in 2010.

42.c. Positive adjustment of $30,000 for

AMT in 2011.

42.d. Regular income tax recognized

gain of $80,000; AMT recognized gain of $50,000.

43.a. Regular income tax recognized

gain of $11,000; AMT recognized gain of $11,000.

43.b. AMT positive adjustment of $3,500

in 2006; AMT negative adjustment of $3,500 in 2007.

44.a. Regular income tax recognized

gain of $314,000 on the building.

44.b. AMT recognized gain of $270,000

on the building.

44.c. Negative AMT adjustment of

$44,000.

45. No deduction; $11,750 suspended

regular tax; $3,000 suspended AMT. 46.a. $14,500. 46.b. $9,500. 46.c. $5,000 positive. 47.a. $13,300. 47.b. $6,400 positive. 48. $4,500 positive.

49. Regular income tax $10,000; AMT

$11,500.

50.a. $17,450 positive.

50.b. $17,450 positive and $1,100 tax

preference. 51. $229,450. 52. $9,000 tax preference. 53. $24,000. 54. $52,450. 55. $76,400 taxable income; $24,180 tentative AMT. 56.a. AMTI $364,500. 56.b. Tentative AMT $97,335. 57.a. $126,450. 57.b. $35,751.

58. Regular income tax is $12,031 and

AMT is $6,584.

59. $64,965.

60.a. Exempt initially from AMT as a

‘‘small corporation’’ in 1998. 60.b. No. 61. 2005 $750 positive; 2006 $750 positive; 2007 $1,500 negative. 62. Quincy $22,000; Redland $24,500; Tanzen $64,000. 63.a. $884,000.

63.b. AMTI $4,690,000; tentative AMT

$938,000.

63.c. AMT $54,000.

64. $36,955 regular tax liability plus

$8,037 AMT.

65. $1,063 regular tax liability plus

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DISCUSSION QUESTIONS

1. Through the use of exclusions, deductions, and credits, the regular income tax liability can

be reduced or eliminated. Congress felt that some taxpayers with substantial economic incomes were taking undue advantage of these tax reduction opportunities and thereby were concerned about the inequality that resulted. Therefore, the AMT was enacted. p. 12-2

2. Starting with taxable income in calculating the AMT is the indirect approach. This is the

approach normally used and the one followed in Form 6251. However, the AMT also can be calculated using the direct approach.

Gross income computed by applying the AMT rules

Minus: Deductions computed by applying the AMT rules

Equals: AMTI before tax preferences

Plus: Tax preferences

Equals: AMT income

Minus: Exemption

Equals: AMT base

Times: Rates

Equals: Tentative AMT before foreign tax credit

Minus: AMT foreign tax credit

Equals: Tentative AMT

Minus: Regular income tax liability before credits other than the foreign tax credit

Equals: AMT

Note that both approaches produce the same amount of AMT. pp. 12-3, 12-4, and Figure 12-1

3. Tax preferences are always positive. Through the use of tax preferences, the AMT is

designed to take back part or all of the tax benefits of certain exclusions or deductions allowed to taxpayers for regular income tax purposes.

AMT adjustments can be both positive and negative. Most, although not all, AMT adjustments are timing differences in the treatment for regular income tax purposes and AMT purposes. As such, the adjustments will reverse and eventually net to zero.

pp. 12-3 and 12-5

4. a., d., and e. are tax preferences for the AMT. p. 12-5

5. d. and e. are tax preferences for the AMT. a. and b. are neither an AMT adjustment nor a

tax preference. c. is an AMT adjustment. Concept Summary 12-1

6. The AMT tax formula is as follows:

Regular taxable income Plus or minus: Adjustments

Equals: Taxable income after AMT adjustments

Plus: Tax preferences

Equals: Alternative minimum taxable income

Minus: AMT exemption

Equals: Alternative minimum tax base

Times: 26% or 28% rate

Equals: Tentative AMT before foreign tax credit

Minus: Alternative minimum tax foreign tax credit

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Minus: Regular tax liability*

Equals: Alternative minimum tax (if amount is positive)

*Regular tax liability for the year reduced by any allowable foreign tax credit. Figure 12-2

7. The statement is correct. There is an AMT liability only if the tentative AMT exceeds the

regular income tax liability. The amount of the excess is the AMT. The total tax liability is the summation of the regular income tax liability and the AMT. pp. 12-7, 12-8, and Figure 12-2

8. a. The AMT exemption can be thought of as a materiality amount. It relieves

taxpayers who do not have substantial adjustments and preferences from the burden of the AMT.

b. The initial amount (prior to the phaseout) of the exemption is as follows:

l $40,250 for a single taxpayer or a head of household.

l $58,000 for married taxpayers filing jointly.

l $29,000 for married taxpayers filing separately.

c. The phaseout of the exemption amount is an application of the wherewithal to pay

concept. As the ability to pay increases as measured by the taxpayer’s AMTI, the justification for relieving the taxpayer of the burden of the AMT decreases.

d. l $273,500 for a single taxpayer or a head of household.

l $382,000 for married taxpayers filing jointly.

l $191,000 for married taxpayers filing separately.

pp. 12-7 and 12-8

9. There are two AMT rates for the individual taxpayer. The rates are multiplied by the AMT

base to produce the tentative AMT (before foreign tax credit). The 26% rate applies to the first $175,000 ($87,500 for married filing separately) of the AMT base, and the 28% rate applies to the excess over $175,000. If the individual taxpayer has net capital gain, the alternative tax rate that is used in the regular tax liability calculation is also available for AMT purposes. p. 12-7

10. Historically only the foreign tax credit was allowed as a reduction of the tentative minimum

tax. However, for tax years 2000–2005, all nonrefundable personal credits can offset both the regular income tax (less foreign tax credit) and AMT. For years after 2005, only certain nonrefundable personal tax credits (i.e., child tax credit, adoption expenses credit, and credit for elective deferrals and IRA contributions) can offset both the regular income tax (less any foreign tax credit) and the AMT in full after all other nonrefundable personal tax credits have been utilized. pp. 12-8 and 12-9

11. Since Tad placed the machinery in service prior to January 1, 1999 (and assuming it was

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years of an asset’s life (e.g., 1998). Conversely, the ADS deduction is larger than the MACRS deduction in the later years (e.g., 2006). p. 12-11

12. For regular income tax purposes, mining exploration and development costs may be

expensed in the year incurred. For AMT purposes, such costs must be amortized over 10 years. The AMT adjustment for mining exploration and development costs is equal to the amount expensed minus the amount that would have been allowed if the costs had been capitalized and amortized ratably over a 10-year period. The AMT adjustment can be avoided if the taxpayer elects to write off the costs over a 10-year period for regular income tax purposes. p. 12-11

13. Rick may be misinformed regarding the AMT. Merely because the AMT exemption amount

is zero and there are adjustments or tax preferences present does not automatically mean an AMT will result. What Rick needs to do is to determine if an AMT (and the amount) would result if he expenses the mining exploration and development costs for regular income tax purposes. p. 12-11

14. For a long-term contract, taxpayers are required to use the percentage of completion

method for AMT purposes. If a taxpayer uses the completed contract method for regular income tax purposes, this will give rise to an AMT adjustment equal to the difference between income reported under the percentage of completion method and the amount reported using the completed contract method. The adjustment can be either positive or negative depending on the amount of income recognized under the different methods. pp. 12-11 and 12-12

15. For regular income tax purposes, the spread between the fair market value of the stock

and the option price in the year of exercise is not recognized. For AMT purposes, however, the spread is recognized and is treated as a positive adjustment. In the year the stock is sold, there will be an equivalent negative adjustment. This negative adjustment occurs because the regular income tax basis is less than the AMT basis by the amount of the spread.

However, if the exercise of the ISO and the sale of the stock occur in the same year, the potential positive adjustment and negative adjustment offset each other. If the exercise of the ISO and the sale occur in different years, there will be a positive AMT adjustment in the exercise year and a negative AMT adjustment in the sale year.

p. 12-12

16. The regular income tax adjusted basis for the building is determined by subtracting the

regular income tax depreciation deductions. The AMT adjusted basis for the building is determined by subtracting the AMT depreciation deductions. Since the regular income tax and the AMT depreciation deducion are not the same for a building placed in service before January 1, 1999, the adjusted basis for regular income tax and AMT purposes will differ. Consequently, the recognized gain or loss for regular income tax and AMT purposes will also differ. pp. 12-12 to 12-14

17. The relevant issues are the tax consequences of each of the two proposed transactions for

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Note also that for regular income tax purposes, any portion of the $85,000 recognized gain that is classified as ordinary income will be subject to a lower tax rate in 2006 (25%) than in 2007 (28%). pp. 12-12 to 12-14

18. Income or loss from passive activities is computed differently for regular income tax

purposes and for AMT purposes. For example, the depreciation and depletion rules differ for regular income tax and AMT purposes. The resulting difference in net income (loss) could require an AMT adjustment. Example 14

19. Positive adjustments and tax preferences are added to the regular income tax NOL in

calculating the ATNOLD (i.e., making the ATNOLD a smaller amount). Negative adjustments are subtracted from the regular income tax NOL in calculating the ATNOLD. p. 12-15

20. The medical expense may cause an adjustment since the expense is subject to a floor of

7.5% of AGI for regular income tax purposes and 10% of AGI for AMT purposes. All of the taxes will be an adjustment since taxes are not deductible for AMT purposes. The home mortgage interest is an adjustment if the loan was not used to buy, build, or improve a principal residence or qualified dwelling. The investment interest may result in an adjustment. The unreimbursed employee business expenses will result in an adjustment if they exceed 2% of AGI. No adjustment is required for charitable contributions or casualty and theft losses. Furthermore, gambling losses are deductible to the extent of gambling winnings for both regular income tax and AMT purposes; therefore, no adjustment is required. pp. 12-16 to 12-19

21. The obvious issue is whether Matt should follow the friend’s advice in order to increase his

itemized deductions. On the surface, this appears to be sound tax advice. Factoring in the effect of indexing on the standard deduction, it appears that Matt may have to use it in the future. Incurring the mortgage on the beach house would enable him to continue to itemize deductions. However, another issue that needs to be addressed is whether Matt will be subject to the AMT. The mortgage interest on the beach house will be deductible for AMT purposes, since it is qualified housing interest. In addition, determination needs to be made of whether the tax-exempt bonds in which Matt is investing are private activity bonds, since the interest on such bonds is a tax preference. pp. 12-17 and 12-21

22. The 3% cutback adjustment does not apply in calculating AMTI. Thus, to negate its effect,

Warren has a negative adjustment of $4,000 ($25,000 $21,000) in calculating AMTI.

p. 12-16

23. The interest deduction for regular income tax purposes includes qualified residence

interest, investment interest to the extent of net investment income reported in computing taxable income, and qualified interest on student loans (i.e., a deduction for AGI). The alternative minimum tax itemized deduction for interest includes qualified housing interest, plus other interest to the extent of qualified net investment income that is included in the AMT base, and qualified interest on student loans. Qualified housing interest could be less than qualified residence interest. pp. 12-17 to 12-19

24. A taxpayer who does not itemize is required to make an adjustment (positive) for the

standard deduction. The adjustment is required because the standard deduction is not allowed for AMT purposes and the starting point for AMT is taxable income. Similarly, a positive adjustment is required for personal and dependency exemptions in calculating AMTI. p. 12-19

25. A tax preference is created for AMT purposes once the adjusted basis of the mineral

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26. In comparing the two alternative investments, contrast the after-tax cash flow from each investment. Thus, Ian’s marginal tax rate is relevant in determining the after-tax cash flow from the taxable bonds. In addition, if the tax-exempt bonds are private activity bonds, this could result in Ian being subject to the AMT and could affect his calculation of the invest-ment interest deduction under the regular income tax. pp. 12-18 and 12-21

27. The purpose of the AMT credit is to provide equity for the taxpayer when timing differences

that give rise to AMT adjustments reverse. The credit arises when positive adjustments are included in the AMT base. It is used to reduce the regular income tax liability for prior years’ AMT liability attributable to timing differences.

To determine the amount of the AMT credit, it is necessary to compute the AMT with tim-ing adjustments and AMT exclusions (non-timtim-ing adjustments and preferences) included in the AMT base. The AMT credit carryover is the difference between the amount so com-puted and the AMT that would result without including timing adjustments in the AMT base. The AMT credit may be carried over indefinitely. Examples 29 to 31 and related discussion

28. To be exempt from the AMT, a corporation must be a ‘‘small corporation.’’ A corporation is

classified as a small corporation if it had average annual gross receipts of less than $5 mil-lion for the three-year period beginning after December 31, 1993. A corporation will con-tinue to be classified as a small corporation if its average annual gross receipts for the three-year period preceding the current tax year and any intervening three-year periods do not exceed $7.5 million. However, if a corporation ever fails the gross receipts test, it is ineligible for small corporation classification in future tax years. Note that a corporation will automatically be classified as a small corporation in the first year of existence. pp. 12-26 and 12-27

29. The ACE adjustment applies only to the corporate taxpayer. It can be either a positive or a

negative amount. AMTI is increased by 75% of the excess of adjusted current earnings (ACE) over unadjusted AMTI. Conversely, AMTI is reduced by 75% of the excess of unadjusted AMTI over ACE. However, the negative adjustment is limited to the aggregate of the positive adjustments under ACE for prior years, reduced by the previously claimed negative adjustments. pp. 12-28 and 12-29

30. Since Rose’s regular income tax liability is $114,000, it is in the 39% tax bracket. The

cor-porate AMT rate is 20%. Therefore, if Rose will be in the 39% bracket next year and the AMT will not apply, it would be beneficial for Rose to accelerate the $20,000 of income into the current tax year. p. 12-31

PROBLEMS

31. Reba’s taxable income $210,000

Plus: Positive AMT adjustments 72,000

Tax preferences 30,000

Less: Negative AMT adjustments (62,000)

Equals: AMTI $250,000

Less: Exemption [$40,250 25%($250,000 $112,500)] (5,875)

Equals: AMT base $244,125

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32. a. _{Calculation of regular income tax liability:} Tax on $145,000: On $74,200 $ 15,108 On $70,800 28% 19,824 $ 34,932 Calculation of AMT: Taxable income $145,000 Adjustments 62,000 Tax preferences 50,000 AMTI $257,000 Exemption [$40,250 25%($257,000 $112,500)] (4,125) AMT base $252,875 Rate: 26% $175,000 $45,500 28% $77,875 21,805 Tentative AMT $ 67,305

Regular income tax liability (34,932)

AMT $ 32,373

b. Arthur’s total tax liability is $67,305, the summation of the regular tax liability of

$34,932 and the AMT of $32,373.

c. Hoffman, Smith, and Willis, CPAs

5191 Natorp Boulevard Mason, OH 45040 February 6, 2007 Mr. Arthur East 100 Colonel’s Way Conway, SC 29526 Dear Mr. East:

As you requested, we have calculated your Federal tax liability for 2006. The total amount is $67,305. This consists of the regular income tax liability of $34,932 and the alternative minimum tax (AMT) liability of $32,373. The calculation of the regu-lar income tax liability appears on Form 1040.

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I would like to work with you to minimize your AMT in the future. Since this is our first year to do tax compliance work for you, we think we can use tax planning tech-niques to reduce your Federal tax liability. Please call me so we can schedule a meeting at a time convenient to you.

Sincerely, Steve Ash, CPA Partner

Figure 12-2

33. Case 1

Married

filing jointly Single

Tentative AMT $194,000 $194,000

Regular tax liability (157,001)** (163,611)*

= AMT $ 36,999 $ 30,389

Case 2

Married

filing jointly Single

Tentative AMT $175,000 $175,000

Regular tax liability (157,001)** (163,611)*

= AMT $ 17,999 $ 11,389 *$97,653 + $65,958 = $163,611. **$91,043 + $65,958 = $157,001. Figure 12-2 34. Single taxpayer: Case 1 $40,250 25%($160,000 $112,500) = $28,375 Case 2 $40,250 25%($250,000 $112,500) = $ 5,875 Case 3 $40,250 25%($450,000 $112,500) = $ –0–

Married filing jointly:

Case 1 $58,000 25%($160,000 $150,000) = $55,500

Case 2 $58,000 25%($250,000 $150,000) = $33,000

Case 3 $58,000 25%($450,000 $150,000) = $ –0–

Married filing separately:

Case 1 $29,000 25%($160,000 $75,000) = $ 7,750

Case 2 $29,000 25%($250,000 $75,000) = $ –0–

Case 3 $29,000 25%($450,000 $75,000) = $ –0–

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35. a. Leona’s AMT is $0.

Tentative AMT $ 78,000

Regular income tax liability (135,000)

Excess of tentative AMT over regular tax liability ($ 57,000)

Since the result is negative, Leona has no AMT.

b. The nonrefundable credits cannot reduce the regular income tax liability below the

amount of the tentative AMT. Therefore, Leona can use only $57,000 of the $65,000 nonrefundable credits to reduce her regular income tax liability to $78,000

($135,000 $57,000). The remaining $8,000 ($65,000 $57,000) of

nonrefund-able credits will be lost unless they are the type of credits which qualify for carry-back and/or carryforward.

pp. 12-8, 12-9, and Figure 12-2

36. Angela has two options available for the $153,000 of circulation expenditures. First, she

could deduct the entire $153,000 in 2006. If she does this, she will have a positive AMT

adjustment of $102,000 ($153,000 $51,000) in 2006 and negative AMT adjustments of

$51,000 ($0 $51,000) in 2007 and 2008.

Under the second option, Angela could elect to capitalize the circulation expenses and deduct them over a 3-year period (i.e., $51,000 per year). If this election is made, there is no AMT adjustment, since the deduction will be the same for regular income tax purposes and AMT purposes.

The 28% bracket for single taxpayers begins at $74,200 and ends at $154,800 in 2006. The first $7,550 is taxed at 10%, the next $23,100 is taxed at 15%, and the next $43,550 is taxed at 25%.

If Angela deducts the entire $153,000 in 2006, she will have zero taxable income. As a result, she will have used $7,550 of the $153,000 deduction to offset income that would be taxed at 10%, $23,100 of the $153,000 deduction to offset income that would be taxed at a 15% rate, $43,550 to offset income that would be taxed at the 25% rate, and $78,800 to off-set income that would be taxed at 28%. Her maximum potential savings from this strategy

will be $15,108 (the tax on $74,200) plus 28% on the remainder of $78,800 ($153,000

$74,200). Thus, the tax effect of the $153,000 deduction would be $37,172 [$15,108 + .28($78,800)].

The 28% bracket spans more than $51,000 in 2006 ($154,800 $74,200 = $80,600), and

the 28% bracket is likely to span a similar range in 2007 and 2008. If Angela writes off the circulation expenditures over three years at the rate of $51,000 per year, the entire $153,000 deduction will offset income that would be taxed at 28% (i.e., 28% in 2006 and 28% in 2007 and 2008). Therefore, Angela should be advised that she can achieve sub-stantial tax savings by amortizing the circulation expenditures over a three-year period. Her tax savings from a $153,000 deduction spread over 3 years at 28% in 2006 and 28% in

2007 and 2008 would be $42,840 [($51,000 28%) + ($51,000 28%) + ($51,000

28%)].

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Note: The time value of money should be considered in computing the final tax savings achieved by the three-year amortization strategy.

p. 12-8

37. Computation of adjustment for circulation expenditures:

2006 regular income tax deduction $150,000

2006 AMT deduction ($150,000/3) (50,000)

Positive AMT adjustment in 2006 $100,000

2007 regular income tax deduction $ 90,000

2007 AMT deduction: [($150,000/3) + ($90,000/3)] (80,000)

Positive AMT adjustment in 2007 $ 10,000

p. 12-8 and Example 3

38. a. If the apartment building is acquired and placed in service in 1998, there is an AMT

positive adjustment for 2006 because the regular income tax cost recovery period is 27.5 years and the AMT cost recovery period is 40 years.

Regular income tax cost recovery for 2006 (Table 8-6):

$750,000 3:636% ¼ $27,270

AMT cost recovery for 2006 (Table 8-7):

$750,000 2:500% ¼ $18,750

Thus, the amount of the AMT adjustment is $8,520 ($27,270 $18,750).

b. If the apartment building is acquired and placed in service in 2006, there is no AMT

adjustment for cost recovery for 2006 because the regular income tax cost recovery period of 27.5 years also is used for AMT purposes.

Regular income tax cost recovery for 2006 (Table 8-6):

$750,000 2:879% ¼ $21,593

AMT cost recovery for 2006 (Table 8-7):

$750,000 2:879% ¼ $21,593

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39. a. In order to produce the largest depreciation deduction for regular income tax pur-poses, Helen will use Table 8-1 (200% DB method). For AMT purpur-poses, she must use Table 8-4 (150% DB method).

Regular income tax depreciation ($300,000 20%) $60,000

AMT depreciation ($300,000 15%) (45,000)

Positive adjustment $15,000

b. Helen could elect to depreciate the equipment using Table 8-4 (150% DB method)

for regular income tax purposes rather than under the regular MACRS method (200% DB method). The election reduces the depreciation percentage factor from 20% to 15%. Therefore, the depreciation deduction for both AMT purposes and regular income tax purposes would be $45,000.

Making the election reduces the AMT adjustment to $0. Such an election may be beneficial if Helen is going to be subject to the AMT. The election would not be ben-eficial if Helen’s regular income tax liability is going to exceed her tentative AMT anyway.

c. Hoffman, Smith, and Willis, CPAs

5191 Natorp Boulevard Mason, OH 45040 August 9, 2006 Ms. Helen Carlon 500 Monticello Avenue Glendale, AZ 85306 Dear Ms. Carlon:

In response to your inquiry regarding the appropriate depreciation method for the $300,000 of used equipment placed in service during March 2006, two options are available. The first will produce a larger depreciation deduction, but may result in the AMT being paid. The second option will produce a smaller depreciation deduc-tion, but will have no effect on the AMT. Note that as we discussed, you decided not to elect § 179 limited expensing treatment.

Under the first option, depreciation is calculated using the 200% declining balance method with a 5-year recovery period. The amount of the depreciation deduction

under this method is $60,000 ($300,000 20%). However, for AMT purposes, the

depreciation is calculated using the 150% declining balance method with a 5-year recovery period. The amount of the depreciation deduction for AMT purposes is

$45,000 ($300,000 15%). Therefore, for AMT purposes, there will be a positive

adjustment of $15,000 ($60,000 $45,000).

Under the second option, depreciation for regular income tax purposes and AMT purposes is calculated using the depreciation method and recovery period required for AMT purposes. Thus, in both cases, the amount of the depreciation deduction is $45,000. The benefit of electing to calculate the regular income tax depreciation this way is that the aforementioned positive adjustment for AMT purposes is avoided.

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on your AMT status absent the effect of the depreciation deduction. In order to advise you regarding this election, I need to meet with you to obtain additional tax information. Please provide me with a date and time that is convenient to you. Sincerely,

James Singer, CPA Partner

pp. 12-10 and 12-11

40. a. Mining exploration and development costs can be expensed in the year incurred

for regular income tax purposes. These expenditures must be amortized over a 10-year period for AMT purposes. Gary’s regular income tax deduction would be $600,000 in 2006 and his AMT deduction would be $60,000 ($600,000/10). There-fore, Gary would have a positive adjustment of $540,000 in 2006 ($600,000 regular

income tax deduction $60,000 AMT deduction). His negative adjustment for each

of the next nine years will be $60,000 ($0 regular income tax deduction $60,000

AMT deduction).

b. Gary can avoid having an adjustment by electing to amortize the mining exploration

and development costs over a ten-year period for regular income tax purposes.

c. Gary should consider the present value of the cash flows, different tax brackets

between regular income tax and AMT, and the possible effect this adjustment will have on future AMT calculations.

Example 9 and related discussion

41. For 2006, there is a positive AMT adjustment of $120,000.

AMT:

Revenues ($500,000 60%) $300,000

Expenses (180,000) $ 120,000

Regular income tax:

Revenues $ –0–

Expenses (–0–) (–0–)

AMT adjustment $ 120,000

For 2007, there is a negative AMT adjustment of $120,000. AMT:

Revenues ($500,000 $300,000) $200,000

Expenses ($295,000 $180,000) (115,000) $ 85,000

Regular income tax:

Revenues $500,000

Expenses (295,000) (205,000)

AMT adjustment ($ 120,000)

(16)

42. a. For regular income tax purposes and for AMT purposes, there are no tax results which need to be reported in 2006, the year of grant.

b. For regular income tax purposes and for AMT purposes, there are no tax results

which need to be reported in 2010, the year of exercise.

c. For regular income tax purposes, the spread of $30,000 ($100,000 fair market

value $70,000 option price) is not recognized in 2011, the year when rights in the

stock become freely transferable and are not subject to a substantial risk of forfeit-ure. For AMT purposes, however, the spread of $30,000 is a positive AMT adjust-ment in 2011.

d. The regular income tax basis of $70,000 is different from the AMT basis of

$100,000 ($70,000 + $30,000). Thus, there is a negative AMT adjustment in 2014,

the year of sale, of $30,000 ($80,000 $50,000).

Regular Income Tax AMT

Amount realized $150,000 $150,000

Amount basis (70,000) (100,000)

Recognized gain $ 80,000 $ 50,000

p. 12-12

43. a. No AMT adjustment is required on the exercise of the ISO because the stock is sold

in the same tax year as its exercise. Also, no adjustment is required for the stock sale because the recognized gain for regular income tax and AMT purposes is the same.

Basis (21,000) (21,000)

Realized gain $11,000 $11,000

Recognized gain $11,000 $11,000

b. If Lori had sold the stock in 2007 (rather than in 2006), her recognized gain for

regular income tax and for AMT purposes would have been as follows:

Basis (17,500) (21,000)

Realized gain $14,500 $11,000

Recognized gain $14,500 $11,000

The result is a positive AMT adjustment of $3,500 ($3,500 $0) in 2006 and a

negative AMT adjustment of $3,500 ($11,000 $14,500) in 2007.

(17)

44. a. _{Amount realized} _$720,000

Less: Adjusted basis (406,000)

Realized and recognized gain $314,000

b. Amount realized $720,000

Less: Adjusted basis (450,000)

Realized and recognized gain $270,000

c. Gain for regular income tax purposes $314,000

Less: Gain for AMT purposes (270,000)

Negative AMT adjustment $ 44,000

pp. 12-12 to 12-14

45. The 2006 loss will not be deductible either for regular income tax or AMT purposes, since

no passive income is present. The suspended passive loss for regular income tax

purposes is $11,750 ($160,000 gross income $122,000 operating expenses $49,750

regular income tax depreciation). The suspended passive loss for AMT purposes is $3,000

($160,000 gross income $122,000 operating expenses $41,000 ADS depreciation).

Examples 15 and 16 and related discussion

46. a. All of the medical expenses are eligible for the medical expense deduction.

There-fore, for regular income tax purposes, Wally’s and Gloria’s medical expense

deduc-tion is $14,500 [$29,500 7.5%($200,000)].

b. For AMT purposes, only the medical expenses in excess of 10% of AGI can be

deducted. Therefore, the medical expense deduction is $9,500 [$29,500 10%

($200,000)].

c. The AMT adjustment for medical expenses is a positive adjustment of $5,000

($14,500 $9,500).

Example 20

47. a. Wolfgang’s itemized deductions for AMT purposes are calculated as follows:

Medical expenses [$12,000 (10% $140,000)] $ –0–

Charitable contributions 5,000

Qualified housing interest 6,500

Casualty loss 1,800

Total $13,300

(18)

b. The AMT adjustment is calculated as follows:

Itemized deductions for regular income tax $19,700

Less: Itemized deductions for AMT purposes (13,300)

Positive AMT adjustment $ 6,400

pp. 12-16 to 12-18

48. For regular income tax purposes, the following amounts are deductible as qualified

residence interest:

Interest on personal residence $12,000

Interest on cabin 6,000

Interest on home equity loan 4,500

Total qualified residence interest deduction $22,500

For AMT purposes, however, the deduction is limited to qualified housing interest, which includes the following:

Interest on personal residence $12,000

Interest on cabin 6,000

Total qualified housing interest deduction $18,000

Interest on the home equity loan of $4,500 is not deductible for AMT purposes because the proceeds were not used to substantially improve a qualified residence. Therefore, an AMT adjustment is required:

Total qualified residence interest deduction $22,500

Total qualified housing interest deduction (18,000)

Positive AMT adjustment $ 4,500

pp. 12-17 and 12-18

49. For regular income tax and AMT purposes, investment interest expense is limited to net

investment income. Therefore, Yoon’s regular income tax deduction for investment interest expense is limited to $10,000 (the amount of dividends received). For regular income tax purposes, the private activity bond interest of $5,000 is excludible from gross income and the related $3,500 interest expense is not deductible. The $5,000 interest income on the private activity bonds is offset by the $3,500 interest expense, so Yoon reports a $1,500 tax preference for AMT purposes. In addition, the net investment income of

$1,500 ($5,000 $3,500) from the private activity bonds is treated as part of net

(19)

50. a. Walter and Edith’s itemized deductions are calculated as follows: Regular

Income Tax AMT Adjustment

Medical expenses (see Note 1) $ 1,250 $ –0– $ 1,250

State income taxes 2,800 –0– 2,800

Personal property tax 900 –0– 900

Real estate tax 9,100 –0– 9,100

Interest on residence 8,600 8,600 –0–

Interest (home equity) 1,800 –0– 1,800

Investment interest 2,600 2,600 –0–

Charitable contribution 4,200 4,200 –0–

Employee expenses (Note 2) 1,600 –0– 1,600

Totals $32,850 $15,400 $17,450

Notes

(1) Medical expenses:

For regular income tax [$9,500 (7.5% $110,000)] $1,250

For AMT [$9,500 (10% $110,000)] (–0–)

Positive adjustment $1,250

(2) Unreimbursed employee expenses:

Expenses $3,800

2% of AGI ($110,000) (2,200)

Deduction for regular income tax $1,600

b. Walter and Edith would have a positive adjustment of $17,450, as computed above.

In addition, they would have a tax preference of $1,100 ($5,000 interest on private

activity bonds $3,900 related interest expense).

pp. 12-16 to 12-19

51. There are positive AMT adjustments of $5,150 for the standard deduction and $3,300 for

the personal exemption. Alternative minimum taxable income is $229,450 ($112,000 taxable income + $109,000 preferences + $5,150 standard deduction + $3,300 exemp-tion). Examples 24 and 25 and related discussion

52. Emily’s percentage depletion deduction for regular income tax purposes is $21,000

($140,000 income 15% depletion rate). This results in a tax preference of $9,000

($21,000 percentage depletion $12,000 basis at beginning of year). Example 26

53. Amos’s preference item for IDC is computed as shown below:

IDC expensed in the year $70,000

Less: IDC if amortized over 10 years (7,000)

Excess IDC $63,000

Less: 65% of $60,000 net income from oil and gas (39,000)

IDC preference $24,000

(20)

54. $9,000 interest on private activity bonds + $35,000 bargain element on incentive stock options + $5,150 standard deduction + $3,300 personal exemption = $52,450. pp. 12-12, 12-19, and 12-21

55. Pat’s tentative AMT for 2006 is computed as shown below:

Taxable income computation

Salary $ 90,000

Interest income 1,000

Dividend income 5,000

Gambling income 4,000

Adjusted gross income $100,000

Itemized deductions:

Medical expenses ($12,000 $7,500) $4,500

State income taxes 4,100

Real estate taxes 2,800

Mortgage interest on residence 3,100

Investment interest expense 1,800

Gambling losses (limited to gambling income) 4,000

Total itemized deductions (20,300)

Personal exemption (3,300)

Taxable income $ 76,400

Tentative minimum tax computation

Plus adjustments:

Medical expenses 2,500

Regular income tax [$12,000 (7.5% $100,000) = $4,500]

AMT [$12,000 (10% $100,000) = $2,000]

Personal exemption 3,300

Subtotal $ 89,100

Plus: Preference (interest on private activity bonds) 40,000

Alternative minimum taxable income (AMTI) $129,100

Exemption [$40,250 25%($129,100 $112,500)] (36,100) AMT base $ 93,000 AMT rate .26 Tentative AMT $ 24,180 pp. 12-16 to 12-19 56. a. _{Taxable income} _$273,000

Plus: Positive AMT adjustments 38,000

Less: Negative AMT adjustments (14,000)

Plus: Tax preference items 67,500

(21)

b. AMTI $364,500

Less: AMT exemption [$58,000 .25($364,500 $150,000)] (4,375)

AMT base $360,125 Tentative AMT: $175,000 26% $ 45,500 ($360,125 $175,000) 28% 51,835 $ 97,335 Example 28

57. a. Computation of Tara’s items of AMT adjustments and preferences for 2006:

Incentive stock option adjustment $ 45,000

Excess depreciation on building adjustment ($49,000 $26,000) 23,000

Percentage depletion in excess of property’s adjusted basis preference 50,000

Standard deduction adjustment 5,150

Personal exemption adjustment 3,300

Total adjustments and preferences $ 126,450

b. Calculation of alternative minimum tax:

Taxable income $121,000

Adjustments and preferences 126,450

Less: Exemption amount (Note 1) (6,512)

Alternative minimum tax base $240,938

Tentative minimum tax (Note 2) $ 63,963

Less: Regular income tax on $121,000 (28,212)

Alternative minimum tax $ 35,751

Regular income tax calculation Tax on $121,000:

On $74,200 $ 15,108

On ($121,000 $74,200) at 28% 13,104

Total tax $ 28,212

Notes

(1) Exemption phase-out: ($247,450 $112,500) 25% = $33,738; then

(22)

(2) AMT tax calculations:

$175,000 26% $45,500

($240,938 $175,000) 28% 18,463

Tentative minimum tax $63,963

Concept Summary 12-1 and Examples 24 and 25

58. Taxable income is computed as follows:

Salary $ 33,000

Taxable interest on corporate bonds 1,800

Business income 64,000

Less: Itemized deductions

Medical expenses [$12,000 (7.5% $100,700)] $4,448

Qualified residence interest 9,200

Investment interest ($5,500, but limited to investment

income) 3,700

Cash contributions to various charities 2,900

Less: Personal exemption (3,300)

Taxable income $ 62,652 Income tax on $62,652: On $30,650 $4,220 On ($60,752 $30,650) at 25% 7,526 $ 11,746 On $1,900 at 15% 285 $ 12,031 The AMT is computed as follows:

Plus positive adjustments and tax preferences:

Medical expenses (Note 1) $ 2,518

Depreciation on business property ($3,175 $2,500) 675

Interest on private activity bonds (preference) (Note 2) 30,000

Personal exemption 3,300 50,993

Less negative adjustment: Investment interest (Note 2) (1,800)

Less: AMT exemption [$40,250 .25($111,845 $112,500)] (40,250)

AMT base $ 71,595

AMT rate .26

Less: Regular income tax (12,031)

(23)

Note 1: $12,000 ($100,700 10%) = $1,930 medical expense for AMT. Then,

$4,448 $1,930 = $2,518 adjustment.

Note 2: Investment income for income tax purposes was only $3,700 ($1,800 + $1,900); so the regular income tax deduction for investment interest expense was limited to that amount. For AMT purposes, the net interest on the private activity bonds of $30,000 is included in calculating net investment income. Therefore, all of the investment interest of $5,500 is deducted for AMT purposes. This produces a

neg-ative adjustment of $1,800 ($5,500 $3,700). For AMT purposes, interest on

pri-vate activity bonds is treated as a tax preference. Therefore, Lynn will have a tax preference of $30,000.

pp. 12-16 to 12-19

59. AMT computation

Taxable income $ –0–

Plus: Timing adjustments 200,000

Plus: AMT exclusion items 100,000

AMTI $300,000

Minus: Exemption [$40,250 .25($300,000 $112,500)] (–0–)

AMT base $300,000

Tentative AMT [.26($175,000) + .28($300,000 $175,000)] $ 80,500

Minus: Regular income tax liability (–0–)

AMT $ 80,500

AMT without timing adjustments

Taxable income $ –0–

Plus: AMT exclusion items 100,000

AMTI $100,000

Minus: Exemption [$40,250 .25($100,000 $112,500)] (40,250)

AMT base $ 59,750

Tentative AMT (.26 $59,750) $ 15,535

Minus: Regular income tax liability (–0–)

AMT $ 15,535

Credit carryover computation

AMT $ 80,500

Less: AMT without timing adjustments (15,535)

AMT credit carryover $ 64,965

Examples 29 to 31

60. a. Aqua is first exempt from the AMT for 1998 (the first year for which the exemption is

(24)

1999, 2000, and 2001 if the tax year is 2002; 2000, 2001, and 2002 if the tax year is 2003; 2001, 2002, and 2003 if the tax year is 2004; 2002, 2003, and 2004 if the tax year is 2005; 2003, 2004, and 2005 if the tax year is 2006). For the three-year period which includes 1994, 1995, and 1996, Aqua had average annual gross receipts of:

$4,800,000þ $5,300,000 þ $4,600,000

3 years ¼ $4,900,000

Thus, Aqua passes the $5 million test for this period. For the three-year period which includes 1995, 1996, and 1997, Aqua had average annual gross receipts of:

$5,300,000þ $4,600,000 þ $8,200,000

3 years ¼ $6,033,333

Thus, Aqua passes the $7.5 million test for this period. Aqua is a small corporation for 1998. Thus, it is exempt from the AMT for 1998.

b. Aqua remains exempt from the AMT in 2006. In order to do so, Aqua’s average

annual gross receipts for the three-year period consisting of 1996, 1997, and 1998 do not exceed $7.5 million.

$4,600,000þ $8,200,000 þ $8,500;000

3 years ¼ $7,100,000

Likewise, Aqua’s average annual gross receipts for the three-year period consisting of 1997, 1998, and 1999 do not exceed $7.5 million.

$8,200,000þ $8,500,000 þ $5,200,000

3 years ¼ $7,300,000

$8,500,000þ $5,200,000 þ $8,000,000

3 years ¼ $7,233,333

$5,200,000þ $8,000,000 þ $6,000,000

3 years ¼ $6,400,000

$8,000,000þ $6,000,000 þ $6,200,000

3 years ¼ $6,733,333

$6,000,000þ $6,200,000 þ $6,100,000

(25)

$6,200,000þ $6,100,000 þ $8,000,000

3 years ¼ $6,766,666

Finally, Aqua’s average annual gross receipts for the three-year period consisting of 2003, 2004, and 2005 do not exceed $7.5 million.

$6,100,000þ $8,000,000 þ $7,000,000

3 years ¼ $7,033,333

pp. 12-26 and 12-27

61. 2005 2006 2007

ACE $4,000 $3,000 $2,000

Less: Unadjusted AMTI (3,000) (2,000) (5,000)

Difference $1,000 $1,000 ($3,000)

Rate .75 .75 .75

Adjustment $ 750 $ 750 ($1,500)*

*$2,250 ($3,000 .75) but limited to $750 + $750, or $1,500. Further, the unusable

nega-tive adjustment of $750 ($2,250 $1,500) is lost forever.

Concept Summary 12-2, Example 32, and related discussion

62. Quincy Corporation:

AMTI $150,000

Less: Exemption amount (40,000)

AMT base $110,000

Rate .20

Note: In this case, there is no reduction in the exemption amount because AMTI does not exceed $150,000.

Redland Corporation: Step 1

AMTI $160,000

Less: Threshold amount for exemption (150,000)

Amount by which AMTI exceeds $150,000 $ 10,000

Reduction rate .25

Applicable reduction in exemption amount $ 2,500

Step 2

Exemption amount $ 40,000

Less: Reduction in exemption amount from Step 1 (2,500)

(26)

Step 3

AMTI $160,000

Less: Applicable exemption amount from Step 2 (37,500)

AMT base $122,500 Rate .20 Tentative AMT $ 24,500 Tanzen Corporation: Step 1 AMTI $320,000

Less: Threshold amount for exemption (150,000)

Amount by which AMTI exceeds $150,000 $170,000

Reduction rate .25

Applicable reduction in exemption amount $ 42,500

Step 2

Exemption amount $ 40,000

Less: Reduction in exemption amount from Step 1 (42,500)

Applicable exemption amount $ –0–

Step 3

AMTI $320,000

Less: Applicable exemption amount from Step 2 (–0–)

AMT base $320,000

Rate .20

Note: In this case, the exemption amount is phased out entirely because AMTI exceeds $310,000.

pp. 12-26 to 12-30

63. a. Tax on taxable income of $2,600,000:

$2,600,000 34% ¼ $884,000

b. Taxable income $2,600,000

Adjustments and tax preferences:

Depreciation for regular income tax on realty

in excess of ADS straight-line $ 550,000

Excess amortization of certified pollution control

facilities 450,000

Tax-exempt interest on private activity bonds 1,030,000

Percentage depletion in excess of the property’s

adjusted basis 60,000 2,090,000

AMTI $4,690,000

Less: Exemption (AMTI exceeds $310,000) (–0–)

Alternative minimum tax base $4,690,000

AMT tax rate .20

(27)

c. Tentative AMT $ 938,000

Less: Regular income tax liability (884,000)

AMT $ 54,000

pp. 12-26 to 12-30 CUMULATIVE PROBLEMS

64. Robert and Jane have taxable income for 2005 as follows:

Salary for Robert (Indiana Foundry, Inc.) $ 91,000

Salary for Jane (Carmel Computer Associates) 104,000

Interest income (Carmel National Bank) (Note 1) 3,100

Dividend income (Able Computer Corporation) 4,000

Gambling income (Note 3) 4,200

Award income (Note 4) 6,000

Capital gain (Note 5) 8,000

Deductions from AGI Itemized deductions:

Medical expenses [$16,800 (7.5% $220,300 AGI)] $ 277

State income tax ($3,970 + $4,710) (Note 2) 8,680

Real property tax on personal residence 4,900

Mortgage interest on personal residence 6,400

Contributions ($6,500 + $2,500) 9,000

Gambling losses (Note 3) 4,200

Subtotal $35,757

Minus: reduction under 3% cutback adjustment (Note 6) (2,230)

Exemptions (Note 7) (12,544)

Alternative minimum tax for Robert and Jane is computed as shown below.

Taxable income plus exemptions ($174,229 + $12,544) $186,773

Reduction caused by 3% cutback adjustment for itemized deductions

(Note 6) (2,230)

Subtotal $184,543

Adjustments:

Medical expenses [$277 for regular income tax $0

for AMT (Note 8)] $ 277

Taxes ($8,680 state income tax + $4,900 real

property tax) 13,580

Total adjustment for itemized deductions 13,857

Preference:

Interest on private activity bonds 20,500

Less: Exemption (Note 9) (40,775)

(28)

Less: Amount eligible for alternative tax on net capital gain

(Note 10) $ (12,000)

AMT base subject to ordinary tax rates $166,125

Tentative AMT liability on $166,125 (Note 15) $ 43,192

Tentative AMT liability on $12,000 (Note 16) 1,800

Less: Regular income tax liability (Note 11) (36,955)

AMT $ 8,037

Note 1 – excludible interest income

The Carmel Sanitation District Bonds interest income of $20,500 is excluded from gross income.

Note 2 – state income tax versus sales tax

The state income tax of $8,680 clearly exceeds any sales tax table amount. Note 3 – gambling income and losses

Since their gambling losses of $4,800 exceed the gambling income of $4,200, the excess loss of $600 is disallowed. The $4,200 of gambling income is included in gross income and the allowed $4,200 of gambling losses are classified as an itemized deduction.

Note 4 – award received

The $6,000 that Jane received for the ‘‘Citizen of the Year’’ is included in her gross income. Note 5 – sale of land

Robert’s adjusted basis for the land he purchased is $77,000. So his recognized gain on

the sale of the land is $8,000 ($85,000 amount realized $77,000 adjusted basis).

Rob-ert’s holding period is long term. The gain is classified as long-term capital gain and is eligi-ble for the alternative tax rate.

Note 6 – reduction for 3% cutback adjustment for itemized deductions

This computation determines the reduction in itemized deductions from application of the 3% cutback adjustment. The computation follows the format provided by the IRS in the instructions for Schedule A.

State income tax 8,680

Real property tax on personal residence 4,900

Mortgage interest on personal residence 6,400

Contributions 9,000

Gambling losses 4,200

(29)

Gambling losses 4,200

Total of itemized deductions not subject to reduction (6,777)

Itemized deductions subject to reduction $28,980

80% of $28,980 = maximum cutback adjustment $23,184

AGI $ 220,300

Less: Threshold for married, joint return (145,950)

Excess AGI $ 74,350

3% of $74,350 excess AGI $ 2,230

Reduction (smaller of $23,184 or $2,230) $ 2,230

Note 7 – dependency deductions and phaseout

Robert and Jane qualify for four personal and dependency exemptions. The two depend-ency deductions are for the twins, Ellen and Sean. They do not qualify for a dependdepend-ency deduction for Robert’s daughter, Amy, even though Robert provides over 50% of her sup-port. Margaret, Robert’s former wife, is the custodial parent, and she does not furnish Rob-ert with a signed Form 8332.

$3,200 4 = $12,800

However, because Robert and Jane’s AGI exceeds the threshold amount, the personal and dependency exemptions are subject to the phaseout provision.

AGI $ 220,300

Less: Threshold amount (218,950)

Excess $ 1,350

Divided by $2,500 = .54

Round to 1%

2% = Phaseout percentage 2%

Amount of phaseout ($12,800 2%) $ 256

Personal and dependency exemptions $ 12,800

Less: Phaseout (256)

Deductible personal and dependency exemptions $ 12,544

Note 8 – AMT medical deduction

$220,300 10% = $22,030

$16,800 $22,030 = $0 medical deduction for AMT.

Note 9 – alternative minimum tax exemption

(30)

AMTI $218,900 Less: Threshold (150,000) Excess $ 68,900 25% 25% Amount of phaseout $ 17,225 Exemption amount $ 58,000

Less: Amount of phaseout (17,225)

Deductible exemption amount $ 40,775

Note 10

Amounts eligible for the beneficial 15% rate include the following:

Net capital gain from stock sale $ 8,000

$12,000 Note 11 – regular income tax liability

Tax on $119,950 $ 23,317

28% ($174,229 $119,950) 15,198

$ 38,515 However, since the $8,000 long-term capital gain on the sale of the land and the dividend income of $4,000 are eligible for the beneficial rates for the alternative tax on net capital gain, Robert and Jane’s regular income tax liability is $36,955 rather than the $38,515 cal-culated above.

Tax on $162,229 ($174,229 $12,000):

Tax on $119,950 $23,317

28% ($162,229 $119,950) 11,838

$35,155

Plus: Tax on $12,000 at beneficial rate: $12,000 15% 1,800

Regular income tax liability $36,955

Note 12 – holding period for the land

Robert’s holding period begins on May 15, 2001. Note 13 – Jane’s inheritance

The $600,000 that Jane inherited from her grandfather is excluded from Jane’s gross income.

Note 14 – gift from Uncle Raymond

(31)

Note 15 – tentative AMT liability on AMT base subject to ordinary tax rates

$166,125 26% = $43,192

Note 16 – tentative AMT liability on AMT base eligible for alternative tax on net capital gain The $12,000 amount that qualifies for the alternative tax treatment for regular income tax purposes also qualifies for alternative tax treatment for AMT purposes.

$12,000 15% = $1,800

Note 17 – child tax credit

The twins, Ellen and Sean, satisfy the statutory requirements for the child tax credit. How-ever, Robert and Jane’s AGI of $220,300 results in a full phaseout of the credit (i.e., the phaseout commences at an AGI of $110,000).

See the tax return solution beginning on page 12-35 of the Solutions Manual.

64. Hoffman, Smith, and Willis, CPAs

5191 Natorp Boulevard Mason, OH 45040 April 3, 2006

Mr. and Mrs. Robert Armstrong 1802 College Avenue

Carmel, IN 46302 Dear Bob and Jane:

Your 2005 income tax return is enclosed and indicates that you have a refund of $3,758

($44,992 tax liability $48,750 withholdings).

Because the Carmel Sanitation District bonds are private activity bonds subject to the alter-native minimum tax, $8,037 of the total tax owed is due to the alteralter-native minimum tax. In order to avoid this tax in the future, you might consider changing the investment to tax-free bonds which are not private activity bonds and, therefore, not subject to the alternative min-imum tax. If you have any questions, please call me.

Sincerely,

John Jones, CPA Partner

65. Regular income tax computation:

Free housing (Note 1) $ –0–

Grocery allowance (Note 2) 10,400

Short-term capital gain 44,000

Interest income (Note 3) 12,000

Lottery winnings 9,000

Incentive stock option exercise (Note 4) –0–

Life insurance proceeds (Note 5) –0–

(32)

Real estate rental loss (Note 6) $(25,000)

Alimony (18,000)

Traditional IRA contribution (Note 7) (3,000)

Adjusted gross income $ 29,400

Itemized deductions:

Charitable contribution (Note 8) $ 2,600

Consumer interest (Note 9) –0–

State and local income taxes 3,600

Medical expenses [$4,500 (7.5% $29,400 AGI)](Note 10) 2,295

Gambling losses (Note 11) 8,000

Miscellaneous itemized deductions (Note 12) –0– (16,495)

Personal exemption (Note 13) (3,300)

Income tax on $9,605 (Note 14) $ 1,063

AMT computation:

Adjustments and preferences:

Incentive stock option adjustment $48,000

State and local income taxes 3,600

Medical expenses (Note 15) 735

Personal exemption 3,200

Interest on private activity bonds 49,000

Total adjustments and preferences 104,535

Alternative minimum taxable income $114,140

Less: AMT exemption [$40,250 25%($114,140 $112,500)] (39,840)

AMT base $ 74,300

AMT rate .26

Less: Regular income tax (1,063)

AMT $ 18,255

2006 Tax Liability

Regular income tax liability $ 1,063

Alternative minimum tax 18,255

Total tax liability $ 19,318

Note 1

Because Ron is a minister of the gospel, he can exclude the fair rental value of the parson-age of $2,000 per month.

Note 2

The grocery allowance of $200 per week does not qualify for the § 119 meal exclusion. Note 3

(33)

Note 4

The spread on the ISO of $48,000 ($68,000 $20,000) is not recognized in 2006.

Note 5

The life insurance proceeds of $750,000 are excludible from Ron’s gross income. Note 6

Loss on rental property: Because Ron is an active participant, he may deduct part of the

$55,000 loss ($190,000 $245,000) under the rental real estate exception. Because his

AGI is less than $100,000, the loss allowed under the rental real estate exception is $25,000. The balance of the loss of $30,000 is suspended. p. 12-23

Note 7

The $3,000 contribution to the traditional IRA is a deduction for AGI. If Ron had chosen, he could have contributed an additional $1,000.

Note 8

Because the holding period of the stock is long-term and the stock is an intangible asset, the full fair market value of $1,600 qualifies for the charitable contribution deduction. The $1,000 he gave to the church from the lottery also qualifies.

Note 9

The $3,500 of consumer interest cannot be deducted. Note 10

The $8,500 of medical expenses paid by Ron for the hospital expenses of Kate’s deceased husband are not deductible by Ron because he was not Ron’s dependent.

Note 11

Gambling losses can be deducted only to the extent of gambling income. Thus, all of the $8,000 of gambling losses from the lottery can be deducted since the gambling winnings are $9,000.

Note 12

Miscellaneous itemized deductions are deductible only to the extent they exceed 2% of

AGI ($29,400 2% = $588). The $200 for the safe deposit box rental is classified as a

miscellaneous itemized deduction. Since the $200 is less than the $588, none of it can be deducted.

Note 13

(34)

Note 14

Tax on $7,550 $ 755

15% ($9,605 $7,550) 308

$ 1,063 Note 15

Regular income tax medical deduction $ 2,295

AMT medical deduction (1,560)*

Medical deduction positive adjustment $ 735

*$4,500 (10% $29,400) = $1,560 medical deduction.

(35)

1 Single 4 Head of household (with qualifying person). (See instructions.) If the qualifying person is a child but not your dependent, enter this child’s

Filing Status

2 Married filing jointly (even if only one had income)

3 Married filing separately. Enter spouse’s SSN above & full name here Check only

one box. name here 5 Qualifying widow(er) with dependent child (see instructions)

6a Yourself. If someone can claim you as a dependent, do not check box 6a Exemptions

b Spouse

c Dependents: (2) Dependent’s_{social security}

number

(3) Dependent’s

relationship to you

(1) First name Last name

(4) if qualifying child for child

tax credit (see instrs)

If more than four dependents, see instructions.

d Total number of exemptions claimed

7 Wages, salaries, tips, etc. Attach Form(s) W-2 7

Income _{8 a Taxable interest. Attach Schedule B if required} _{8 a} b Tax-exempt interest. Do not include on line 8a 8 b

9 a Ordinary dividends. Attach Schedule B if required 9a bQualfd divs

(see instrs) 9 b

10 Taxable refunds, credits, or offsets of state and local income taxes (see instructions) 10

11 Alimony received 11

Attach Form(s) W-2 here. Also attach Forms W-2G and 1099-R if tax was withheld.

12 Business income or (loss). Attach Schedule C or C-EZ 12

13 Capital gain or (loss). Att Sch D if reqd. If not reqd, ck here 13

BAA For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see instructions. FDIA0112 11/07/05 Form 1040 (2005)

Boxes checked on 6a and 6b No. of children on 6c who: • lived with you • did not live with you due to divorce or separation (see instrs) Dependents on 6c not entered above Add numbers on lines above Department of the Treasury – Internal Revenue Service

Form

1040

U.S. Individual Income Tax Return

2005

(99) IRS Use Only – Do not write or staple in this space.

For the year Jan 1 - Dec 31, 2005, or other tax year beginning , 2005, ending , 20 OMB No. 1545-0074

Your first name MI Last name Your social security number

Label (See instructions.)

If a joint return, spouse’s first name MI Last name Spouse’s social security number

Home address (number and street). If you have a P.O. box, see instructions. Apartment no. Use the

IRS label.

Otherwise, please print or type.

City, town or post office. If you have a foreign address, see instructions. State ZIP code

You must enter your social security number(s) above. Checking a box below will not change your tax or refund.

Presidential Election Campaign

23 Educator expenses (see instructions) 23

24 Certain business expenses of reservists, performing artists, and fee-basis

government officials. Attach Form 2106 or 2106-EZ 24

Adjusted Gross

Income 25 Health savings account deduction. Attach Form 8889 25

26 Moving expenses. Attach Form 3903 26

27 One-half of self-employment tax. Attach Schedule SE 27

28 Self-employed SEP, SIMPLE, and qualified plans 28

29 Self-employed health insurance deduction (see instructions) 29

30 Penalty on early withdrawal of savings 30

31 a Alimony paid b Recipient’s SSN 31 a

32 IRA deduction (see instructions) 32

33 Student loan interest deduction (see instructions) 33

34 Tuition and fees deduction (see instructions) 34

35 Domestic production activities deduction. Attach Form 8903 35

36 Add lines 23 - 31a and 32 - 35 36

37 Subtract line 36 from line 22. This is your adjusted gross income 37

If you did not get a W-2,

see instructions. 14 Other gains or (losses). Attach Form 4797 14

15 a IRA distributions 15 a b Taxable amount (see instrs) 15 b 16 a Pensions and annuities 16 a b Taxable amount (see instrs) 16 b 17 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E 17

18 Farm income or (loss). Attach Schedule F 18

19 Unemployment compensation 19

20 a Social security benefits 20 a b Taxable amount (see instrs) 20 b

Enclose, but do not attach, any payment. Also, please use

Form 1040-V. 21 Other income 21

22 Add the amounts in the far right column for lines 7 through 21. This is your total income 22

Check here if you, or your spouse if filing jointly, want $3 to go to this fund? (see instructions) You Spouse

ROBERT M ARMSTRONG 224-36-9987 JANE R ARMSTRONG 443-56-3421 1802 COLLEGE AVENUE CARMEL IN 46302 X X X 2 2 4 195,000. 3,100. 20,500. 4,000. 4,000. 8,000.