CHAPTER 14 ALTERNATIVE MINIMUM TAX SOLUTIONS TO PROBLEMS MATERIALS

Question/ Problem 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Topic AMT purpose AMTI: direct versus indirect calculation approach AMT adjustments Tax preferences Tax preferences AMT formula Regular income tax liability versus AMT AMT exemption amount AMT rates AMT and nonrefundable tax credits AMT adjustment for cost recovery on realty AMT adjustment for mining exploration and development costs Issue ID Long-term contract income adjustment Incentive stock options adjustment Regular income tax adjusted basis versus AMT adjusted basis Issue ID Passive activity losses AMT adjustment ATNOLD AMT and itemized deductions Issue ID AMT cutback adjustment AMT and interest AMT and personal and dependency exemptions Percentage depletion preference Private activity bond preference 14-1

Status: Present Edition Unchanged Unchanged Unchanged Modified Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged New New Unchanged Modified Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged

Q/P in Prior Edition 1 2 3 4 5 6 7 8 9 10 11 12 13 16 17 18 19 20 21 22 23 24 26

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2004 Comprehensive Volume/Solutions Manual Status: Present Edition Unchanged New Unchanged Unchanged Unchanged Unchanged Unchanged Modified Unchanged Modified Unchanged Modified Unchanged Unchanged New Unchanged New Unchanged Unchanged Modified Unchanged Unchanged Unchanged New New New Unchanged Unchanged New Unchanged Unchanged New Unchanged Modified Unchanged Unchanged Unchanged Modified Modified 53 54 56 57 59 60 61 62 63 64 65 Q/P in Prior Edition 27 29 30 31 32 33 34 35 36 37 38 39 40 42 44 45 46 47 48 49

Question/ Problem 27 28 29 * * * * * * 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46

Topic Purpose of AMT credit Corporate versus noncorporate AMT Effect of ACE adjustment on financial and tax accounting AMT planning on recognition of income AMT base AMT calculation AMT calculation AMT exemption amount AMT and nonrefundable credits AMT adjustments: circulation expenditures Adjustments for circulation expenditures Cost recovery adjustment for AMT: realty Cost recovery adjustment for AMT: personalty Mining and exploration costs adjustment AMT adjustment for long-term contract Incentive stock option adjustment Adjustments for incentive stock options AMT adjustments: adjusted gain or loss Computing AMT passive loss Itemized deductions adjustment for AMT and medical expenses AMT adjustments for itemized deductions Mortgage interest adjustment for AMT Adjustment for investment interest and private activity bond preference Itemized deductions adjustment for AMT AMT standard deduction and personal exemption adjustments AMT percentage depletion preference AMT IDC preference Tax preference items and AMT adjustments including private activity bonds Comprehensive AMT calculation AMT calculation Computation of taxable income and AMT Computation of taxable income and AMT AMT tax credit carryover Exemption from corporate AMT for small corporations ACE adjustment Corporate AMT Corporate AMT Cumulative Cumulative

* * *

* 47 * 48 49 * 50 51 52 * 53 54 * * * * * * * * * * * 55 56 57 58 59 60 61 62 63 64 65

*The solution to this problem is available on a transparency master.

Alternative Minimum Tax CHECK FIGURES 31. $204,875. 32.a. $27,137. 32.b. $57,365. 33. Case 1: MFJ $26,699; single $21,177. Case 2: MFJ $11,699; single $6,177. 34. Case 1: Single $30,125; MFJ $49,000; MFS $9,500. Case 2: Single $5,125; MFJ $27,750; MFS $0. Case 3: Single $0; MFJ $0; MFS $0. 35.a. $0. 35.b. $78,000. 36. Expensing saves $31,128; amortizing saves $36,080. 37. 2003 positive $90,000; 2004 negative $5,000. 38.a. $3,862 positive adjustment. 38.b. $0. 39.a. $12,500 positive. 39.b. Elect 150% DB method. 40.a. $540,000 positive adjustment for 2003. 40.b. Amortize expenditures over 10 years. 41. $120,000 positive adjustment for 2003; $120,000 negative adjustment for 2004. 42.a. No reporting required in 2003. 42.b. No reporting required in 2007. 42.c. Positive adjustment of $30,000 for AMT in 2008. 42.d. Regular income tax recognized gain of $80,000; AMT recognized gain of $50,000. 43. $27,000 positive AMT adjustment in 2003; $27,000 negative AMT adjustment in 2004. 44.a. Regular income tax recognized gain of $350,000 on the building and $150,000 on the land; AMT recognized gain of $310,000 on the building and $150,000 on the land. 44.b. 45. 46.a. 46.b. 46.c. 47.a. 47.b. 48. 49. 50.a. 50.b. 51. 52. 53. 54. 55. 56. 57.a. 57.b. 58. 59. 60.a. 60.b. 61. 62. 63.a. 63.b. 63.c. 64. 65.

14-3

$40,000 negative adjustment on the building and $0 on the land. No deduction; $11,750 suspended regular tax; $3,000 suspended AMT. $14,500. $9,500. $5,000 positive. $14,500. $8,500 positive. $5,000 positive. Regular income tax $10,000; AMT $11,500. $17,450 positive. $17,450 positive and $1,100 tax preference. $207,800. $9,000 tax preference. $24,000. $51,800. $76,650 taxable income; $25,350 tentative AMT. $17,663. $117,800. $31,667. Total tax is $34,427. $63,795. Exempt initially from AMT as a “small corporation” in 1998. No. 2002 $750 positive; 2003 $750 positive; 2004 $1,500 negative. Quincy $22,000; Redland $24,500; Tanzen $64,000. $1,020,000. AMTI $3,690,000; tentative AMT $738,000. AMT $0. $3,349 regular tax liability plus $20,084 AMT. $43,352 regular tax liability plus $9,648 AMT.

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2004 Comprehensive Volume/Solutions Manual

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. 14-2 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. 14-4, 14-5, and Figure 14-1 3. The statement is correct for AMT adjustments that relate to timing differences (e.g., circulation expenditures and depreciation). However, not all AMT adjustments relate to timing differences (e.g., itemized deductions permitted for regular income tax purposes that are not permitted for AMT purposes). These adjustments do not reverse. pp. 14-4 to 14-6 a., d., and e. are tax preferences for the AMT. p. 14-6 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. pp. 14-4 to 14-6 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 Equals: Tentative minimum tax

2.

4. 5. 6.

Alternative Minimum Tax Minus: Equals: Regular tax liability* Alternative minimum tax (if amount is positive)

14-5

*Regular tax liability for the year reduced by any allowable foreign tax credit. Figure 14-2 7. The statement is incorrect. 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. 14-9 and 14-10 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. The initial amount (prior to the phaseout) of the exemption is as follows:

8.

b.

• • •
c.

$35,750 for a single taxpayer. $49,000 for married taxpayers filing jointly. $24,500 for married taxpayers filing separately.

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.

pp. 14-8 and 14-9 9. In calculating the tentative AMT, the AMT base normally is multiplied by the AMT statutory rates of 26% (on the first $175,000 of the AMT base) or 28% (on the AMT base in excess of $175,000). However, Alice’s net capital gain of $100,000 that is included in the AMT base is eligible for the same alternative tax rate (i.e., 20% for Alice) that is used in the regular tax liability calculation. p. 14-9 Historically the answer was no. Only the foreign tax credit could reduce the regular income tax liability below the amount of the tentative AMT. However, now certain nonrefundable personal credits (e.g., child tax credit, adoption expenses credit, credit for elective deferrals and IRA contributions) are permitted to offset both the regular income tax liability and the AMT. p. 14-10 Andy’s conclusion is wrong. The AMT cost recovery for a warehouse placed in service in 1997 is computed under the alternative depreciation system (ADS), which uses the straight-line method over a 40-year life. The regular income tax cost recovery is computed under the straight-line method over a 39-year life. Thus, the difference between the AMT cost recovery and regular income tax cost recovery on Andy’s warehouse is treated as an adjustment in computing the AMT. Note, however, that for real property placed in service after December 31, 1998, the regular income tax cost recovery period of 39 years (or 27.5 years for residential property) is to be used in calculating the AMT cost recovery. Thus, for such property, there will be no AMT adjustment for cost recovery. pp. 14-11 and 14-12

10.

11.

14-6 12.

2004 Comprehensive Volume/Solutions Manual 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. pp. 14-13 and 14-14 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. pp. 14-7 and 14-13 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. p. 14-14 a. If Megan exercises the incentive stock option (ISO), she will have an AMT adjustment of $4,500 [($65 fair market value – $20 option price) X 100 shares] in the first taxable year in which the rights in the stock are freely transferable or are not subject to a substantial risk of forfeiture. She will not be required to recognize any income for regular income tax purposes as a result of exercising the ISOs. For AMT purposes, the basis of such stock is equal to the fair market value taken into account in determining the adjustment. Examples 10 and 11 and related discussion Yes. If Megan exercises the option and disposes of the stock in the same tax year, there is no AMT adjustment. p. 14-14

13.

14.

15.

b. 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 deductions 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. 14-15 and 14-16 The relevant issues are the tax consequences of each of the two proposed transactions for both regular income tax purposes and for AMT purposes. The AMT analysis is relevant only if the AMT applies since the adjustment would be negative. For regular income tax purposes, the sale to Abby in 2004 would result in deferring the reporting of the gain of $20,000 until 2004. This deferral treatment also would apply for AMT purposes (i.e., the realized loss of $5,000 cannot be recognized). If the sale occurred in 2003 to Ed, for regular income tax purposes, the $20,000 realized gain is recognized. However, for AMT purposes, there would be a $25,000 negative adjustment for the difference between the $20,000 gain for regular income tax purposes and the $5,000 loss for AMT purposes. Note also that for regular income tax purposes, any portion of the $20,000 recognized

17.

Alternative Minimum Tax

14-7

gain that is classified as ordinary income will be subject to a higher tax rate in 2003 (27%) than in 2004 (26%). pp. 14-15 and 14-16 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. pp. 14-16, 14-17, and Example 15 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. pp. 14-17 and 14-18 The tax treatment for regular income tax and AMT purposes is the same for the following: Casualty losses Charitable contributions A deduction for state income taxes, miscellaneous itemized deductions subject to the 2% floor, and real estate taxes is not permitted for AMT purposes. While a deduction is permitted for medical expenses for AMT purposes, the floor is 10% of AGI rather than the 7.5% floor. pp. 14-18 to 14-20 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. 14-20 and 14-23 The purpose of the cutback adjustment for regular income tax purposes is to partially phase out the deduction for itemized deductions for high income taxpayers (i.e., AGI exceeds a threshold amount). The AMT calculation takes a different approach by disallowing certain itemized deductions (e.g., state income taxes, property taxes) and by reducing the amount of others (e.g., medical expenses, qualified housing interest versus qualified residence interest). There is no cutback adjustment in calculating the AMT. Since the starting point for calculating the AMT is taxable income, there is a negative adjustment for the amount of the cutback adjustment in calculating AMTI. p. 14-19 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. 14-19 to 14-21

19.

20.

22.

23.

14-8 24.

2004 Comprehensive Volume/Solutions Manual For regular income tax purposes, a deduction of $3,050 in 2003 is permitted for each personal exemption and dependency deduction (subject to partial phaseout as AGI exceeds a threshold amount). For AMT purposes, the benefit of this deduction is eliminated with a positive adjustment in calculating AMTI. However, in converting AMTI to the AMT base, an AMT exemption is allowed ranging from $24,500 to $49,000 (subject to complete phaseout as AMTI exceeds a threshold amount). If there were not a positive adjustment for the personal and dependency exemptions amount deducted in calculating taxable income, the taxpayer would receive double benefits in calculating the AMT. pp. 14-8, 14-9, and 14-21 A tax preference is created for AMT purposes once the adjusted basis of the mineral deposit is reduced to $0 and percentage depletion continues to be deducted. p. 14-22 For regular income tax purposes, the $18,000 of interest income is excludible from gross income and the $7,000 of interest expense is not deductible. For AMT purposes, interest earned on private activity bonds is included in AMTI. Interest incurred in purchasing or carrying such bonds is offset against the interest income. Also, for AMT purposes, the interest earned (net of any related expenses) on private activity bonds is included in the calculation of net investment income in calculating the investment interest deduction. pp. 14-21 and 14-23 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 timing adjustments and AMT exclusions (non-timing adjustments and preferences) included in the AMT base. The AMT credit carryover is the difference between the amount so computed 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

25. 26.

27.

28.

The AMT applicable to corporations is similar to that applicable to noncorporate taxpayers. However, there are several important differences: • • • • The corporate AMT rate is 20% versus 26% and 28% for noncorporate taxpayers. The AMT exemption for corporations is $40,000 reduced by 25% of the amount by which AMTI exceeds $150,000. Tax preferences applicable to noncorporate taxpayers are also applicable to corporate taxpayers, but some adjustments differ including the ACE adjustment. A small corporation is exempt from the AMT. In addition, all corporations are exempt from the AMT in the first year of existence.

pp. 14-27 to 14-33 29. Through the ACE adjustment, Congress is indirectly imposing a conformity requirement on corporations. While a corporation may still choose to use different methods for tax and financial accounting purposes, it may no longer be able to do so without the possibility of incurring AMT as a result of the ACE adjustment. Thus, a corporation may incur AMT not only because of specifically targeted adjustments and preferences, but

Alternative Minimum Tax

14-9

also as a result of any methods that cause adjusted current earnings to exceed AMTI before the ACE adjustment. pp. 14-30 to 14-32 30. Situations can arise when it would be advisable for a taxpayer to accelerate income into an AMT year. A 27% to 38.6% taxpayer who is subject to the AMT in the current year should consider accelerating income into the AMT year so the income will be taxed at a 26% or 28% rate. For example, collectibles that produce long-term capital gain can be sold in the AMT year, exposing the gain to a possible 26% rate, rather than the 28% alternative capital gains rate that might otherwise apply. Examples 36 and 37 and related discussion

PROBLEMS 31. Rachel’s taxable income Plus: Positive AMT adjustments Tax preferences Less: Negative AMT adjustments Equals: AMTI Less: Exemption [$35,750 – 25%($215,000 – $112,500)] Equals: AMT base pp. 14-4 to 14-9 32. a. Calculation of regular income tax liability: Tax on $120,000: On $68,800 On $51,200 X 30% Calculation of AMT: Taxable income Adjustments Tax preferences AMTI Exemption [$35,750 – 25%($225,000 – $112,500)] AMT base Rate: 26% X $175,000 28% X $ 42,375 Tentative AMT Regular income tax liability AMT b. $45,500 11,865 $ 14,868 15,360 $ 30,228 $120,000 60,000 45,000 $225,000 (7,625) $217,375 $175,000 95,000 25,000 (80,000) $215,000 (10,125) $204,875

$ 57,365 (30,228) $ 27,137

Arthur’s total tax liability is $57,365, the summation of the regular tax liability of $30,228 and the AMT of $27,137.

14-10 c.

2004 Comprehensive Volume/Solutions Manual Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040 February 6, 2004 Mr. Arthur East 100 Colonel’s Way Conway, SC 29526 Dear Mr. East: As you requested, we have calculated your Federal tax liability for 2003. The total amount is $57,365. This consists of the regular income tax liability of $30,228 and the alternative minimum tax (AMT) liability of $27,137. The calculation of the regular income tax liability appears on Form 1040. Since this is the first year that you have been subject to the AMT, I thought that I should comment on this additional tax. The calculation of the AMT appears on Form 6251. The AMT is a parallel income tax system. Its purpose is to provide assurance that no taxpayer with substantial economic income can avoid significant tax liability by using exclusions, deductions, and credits. As indicated on Form 6251, some of the exclusions and deductions on your Form 1040 are disallowed on your Form 6251. Such items are treated as positive adjustments and preferences on Form 6251. 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 techniques 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 pp. 14-7 to 14-9 and Figure 14-2

33.

Case 1 Tentative AMT Regular tax liability AMT * $96,236 + $72,587 = $168,823. ** $90,714 + $72,587 = $163,301.

– =

Married filing jointly Single $190,000 $190,000 (163,301)** (168,823)* $ 26,699 $ 21,177

Alternative Minimum Tax Case 2 Tentative AMT Regular tax liability AMT

14-11

– =

Married filing jointly Single $175,000 $175,000 (163,301)** (168,823)* $ 11,699 $ 6,177

Figure 14-2 34. Single taxpayer: Case 1 $35,750 – 25%($135,000 – $112,500) = Case 2 $35,750 – 25%($235,000 – $112,500) = Case 3 $35,750 – 25%($435,000 – $112,500) = Married filing jointly: Case 1 $49,000 – $0(no exemption phase out) = Case 2 $49,000 – 25%($235,000 – $150,000) = Case 3 $49,000 – 25%($435,000 – $150,000) = Married filing separately: Case 1 $24,500 – 25%($135,000 – $75,000) = Case 2 $24,500 – 25%($235,000 – $75,000) = Case 3 $24,500 – 25%($435,000 – $75,000) = pp. 14-8 and 14-9 35. a. Leona’s AMT is $0. Tentative AMT Regular income tax liability Excess of tentative AMT over regular tax liability 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 nonrefundable credits will be lost unless they are the type of credits which qualify for carryback and/or carryforward. $ 78,000 (135,000) ($ 57,000) $30,125 $ 5,125 $ -0$49,000 $27,750 $ -0$9,500 $ -0$ -0-

pp. 14-9, 14-10, and Figure 14-2 36. Angela has two options available for the $123,000 of circulation expenditures. First, she could deduct the entire $123,000 in 2003. If she does this, she will have a positive AMT adjustment of $82,000 ($123,000 – $41,000) in 2003 and negative AMT adjustments of $41,000 ($0 – $41,000) in 2004 and 2005. Under the second option, Angela could elect to capitalize the circulation expenses and deduct them over a 3-year period (i.e., $41,000 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.

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2004 Comprehensive Volume/Solutions Manual The 30% bracket for single taxpayers begins at $68,800 and ends at $143,500 in 2003. The first $6,000 is taxed at 10%, the next $22,400 is taxed at 15%, and the next $40,400 is taxed at 27%. If Angela deducts the entire $123,000 in 2003, she will have zero taxable income. As a result, she will have used $6,000 of the $123,000 deduction to offset income that would be taxed at 10%, $22,400 of the $123,000 deduction to offset income that would be taxed at a 15% rate, $40,400 to offset income that would be taxed at the 27% rate, and $54,200 to offset income that would be taxed at 30%. Her maximum potential savings from this strategy will be $14,868 (the tax on $68,800) plus 30% on the remainder of $54,200 ($123,000 – $68,800). Thus, the tax effect of the $123,000 deduction would be $31,128 [$14,868 + .30($54,200)]. The 30% bracket spans more than $41,000 in 2003 ($143,500 – $68,800 = $74,700), and the 29% bracket is likely to span a similar range in 2004 and 2005. If Angela writes off the circulation expenditures over three years at the rate of $41,000 per year, the entire $123,000 deduction will offset income that would be taxed at near 30% (i.e., 30% in 2003 and 29% in 2004 and 2005). Therefore, Angela should be advised that she can achieve substantial tax savings by amortizing the circulation expenditures over a threeyear period. Her tax savings from a $123,000 deduction spread over 3 years at 30% in 2003 and 29% in 2004 and 2005 would be $36,080 [($41,000 X 30%) + ($41,000 X 29%) + ($41,000 X 29%)]. In summary, Angela could save $31,128 in income tax if she expenses the circulation expenditures in the year incurred, but could save $36,080 if she amortizes them over 3 years. Note: The time value of money should be considered in computing the final tax savings achieved by the three-year amortization strategy. p. 14-11

37.

Computation of adjustment for circulation expenditures: 2003 regular income tax deduction 2003 AMT deduction ($135,000/3) Positive AMT adjustment in 2003 2004 regular income tax deduction 2004 AMT deduction: [($135,000/3) + ($60,000/3)] Negative AMT adjustment in 2004 p. 14-11 $135,000 (45,000) $ 90,000 $ 60,000 (65,000) ($ 5,000)

38.

a.

If the apartment building is acquired and placed in service in 1997, there is an AMT positive adjustment for 2003 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 2003 (Table 7-9): $340,000 X 3.636% = $12,362 AMT cost recovery for 2003 (Table 7-10): $340,000 X 2.500% = $8,500

Alternative Minimum Tax

14-13

Thus, the amount of the positive AMT adjustment is $3,862 ($12,362 – $8,500). b. If the apartment building is acquired and placed in service in 2003, there is no AMT adjustment for cost recovery for 2003 because the regular income tax cost recovery period of 27.5 years also is used for AMT purposes. Regular income tax cost recovery for 2003 (Table 7-9): $340,000 X 3.485% = $11,849 AMT cost recovery for 2003 (Table 7-9): $340,000 X 3.485% = $11,849 pp. 14-11 and 14-12 39. a. In order to produce the largest depreciation deduction for regular income tax purposes, Helen will use Table 7-1 (200% DB method). For AMT purposes, she must use Table 7-4 (150% DB method). Regular income tax depreciation ($250,000 X 20%) AMT depreciation ($250,000 X 15%) Positive adjustment b. $50,000 (37,500) $12,500

Helen could elect to depreciate the equipment using Table 7-4 (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 $37,500. 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 beneficial if Helen’s regular tax liability is going to exceed her tentative AMT anyway.

c.

Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040 August 8, 2003 Ms. Helen Carlon 500 Monticello Avenue Glendale, AZ 85306 Dear Ms. Carlon: In response to your inquiry regarding the appropriate depreciation method for the $250,000 of equipment placed in service during March 2003, 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 deduction, but will have no effect on the AMT.

14-14

2004 Comprehensive Volume/Solutions Manual 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 $50,000 ($250,000 X 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 $37,500 ($250,000 X 15%). Therefore, for AMT purposes, there will be a positive adjustment of $12,500 ($50,000 – $37,500). 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 $37,500. The benefit of electing to calculate the regular income tax depreciation this way is that the aforementioned positive adjustment for AMT purposes is avoided. Whether the election that produces a smaller depreciation deduction for regular income tax purposes but avoids a positive AMT adjustment is beneficial depends 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. 14-12 and 14-13

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 2003 and his AMT deduction would be $60,000 ($600,000/10). Therefore, Gary would have a positive adjustment of $540,000 in 2003 ($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). 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. 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.

b.

c.

Example 9 and related discussion

Alternative Minimum Tax 41. For 2003, there is a positive AMT adjustment of $120,000. AMT: Revenues ($500,000 X 60%) Expenses $300,000 (180,000) $ -0(-0-)

14-15

$120,000

Regular income tax: Revenues Expenses AMT adjustment

(-0-) $120,000

For 2004, there is a negative AMT adjustment of $120,000. AMT: Revenues ($500,000 – $300,000) Expenses ($295,000 – $180,000) $200,000 (115,000) $500,000 (295,000)

$ 85,000

Regular income tax: Revenues Expenses AMT adjustment p. 14-14 42. a. b. c.

(205,000) ($120,000)

For regular income tax purposes and for AMT purposes, there are no tax results which need to be reported in 2003, the year of grant. For regular income tax purposes and for AMT purposes, there are no tax results which need to be reported in 2007, the year of exercise. For regular income tax purposes, the spread of $30,000 ($100,000 fair market value – $70,000 option price) is not recognized in 2008, the year when rights in the stock become freely transferable and are not subject to a substantial risk of forfeiture. For AMT purposes, however, the spread of $30,000 is a positive AMT adjustment in 2008. 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 2011, the year of sale, of $30,000 ($80,000 – $50,000). Amount realized Amount basis Recognized gain Regular Income Tax $150,000 (70,000) $ 80,000 AMT $150,000 (100,000) $ 50,000

d.

pp. 14-14 and 14-15 43. In 2003, when the rights become freely transferable and are not subject to a substantial risk of forfeiture, Diego has a positive $27,000 adjustment for AMT purposes [($92 – $65) X 1,000 shares]. The transaction has no effect on regular taxable income or alternative minimum taxable income in 1998. There is no effect on regular taxable income in 2003 when the rights in the stock become freely transferable and are not subject to a substantial risk of forfeiture.

14-16

2004 Comprehensive Volume/Solutions Manual When the stock is sold in 2004, the recognized gain for regular income tax purposes and AMT purposes is calculated as follows: Amount realized Amount basis Recognized gain Regular Income Tax $100,000 (65,000) $ 35,000 AMT $100,000 (92,000) $ 8,000

The AMT basis is the fair market value on the exercise date (i.e., $92 per share). Since the gain on the sale for regular income tax purposes exceeds the recognized gain for AMT purposes, there is a $27,000 negative adjustment in calculating AMT. pp. 14-14 and 14-15 44. a. Alicia has a recognized gain for both regular income tax and AMT purposes. Regular Income Tax Amount realized Adjusted basis Realized gain Recognized gain b. Building $800,000 (450,000) $350,000 $350,000 Land $250,000 (100,000) $150,000 $150,000 AMT Building $800,000 (490,000) $310,000 $310,000 Land $250,000 (100,000) $150,000 $150,000

There is no AMT adjustment associated with the sale of the land because the recognized gain for regular income tax purposes and AMT purposes is the same ($150,000). There is a negative AMT adjustment associated with the sale of the apartment building of $40,000 ($310,000 – $350,000). This results because the cost recovery deductions on the building for regular income tax purposes exceed those for AMT purposes by $40,000 ($450,000 adjusted basis – $490,000 adjusted basis). Recognized gain: regular income tax Recognized gain: AMT Negative AMT adjustment $350,000 (310,000) $ 40,000

pp. 14-15 and 14-16 45. The 2003 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 a. All of the medical expenses are eligible for the medical expense deduction. Therefore, for regular income tax purposes, Wally’s and Gloria’s medical expense deduction is $14,500 [$29,500 – 7.5%($200,000)]. 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)].

46.

b.

Alternative Minimum Tax c.

14-17

The AMT adjustment for medical expenses is a positive adjustment of $5,000 ($14,500 – $9,500).

pp. 14-18 and 14-19 47. a. Wolfgang’s itemized deductions for AMT purposes are calculated as follows: Medical expenses [$5,500 – (10% X $60,000)] Charitable contributions Qualified housing interest Casualty loss Total -07,000 6,000 1,500 $14,500 $

Neither the state income taxes of $4,200 nor the miscellaneous itemized deductions of $3,300 are deductible for AMT purposes. An additional 2.5% of AGI ($1,500) is disallowed in calculating medical expenses. Thus, none of the medical expenses are deductible. b. The AMT adjustment is calculated as follows: Itemized deductions for regular income tax Less: Itemized deductions for AMT purposes Positive AMT adjustment pp. 14-18 to 14-21 48. For regular income tax purposes, the following amounts are deductible as qualified residence interest: Interest on personal residence Interest on cabin Interest on home equity loan Total qualified residence interest deduction $12,000 4,800 5,000 $21,800 $23,000 (14,500) $ 8,500

For AMT purposes, however, the deduction is limited to qualified housing interest, which includes the following: Interest on personal residence Interest on cabin Total qualified housing interest deduction $12,000 4,800 $16,800

Interest on the home equity loan 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 Total qualified housing interest deduction Positive AMT adjustment pp. 14-19 and 14-21 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 $21,800 (16,800) $ 5,000

14-18

2004 Comprehensive Volume/Solutions Manual 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 investment income for AMT purposes. Net investment income is $11,500 ($10,000 + $1,500). Therefore, for AMT purposes, $11,500 of the $13,000 investment interest expense can be deducted. pp. 14-20 and 14-21

50.

a.

Walter and Edith’s itemized deductions are calculated as follows: Regular Income Tax $ 1,250 2,800 900 9,100 8,600 1,800 2,600 4,200 1,600 $32,850 AMT -0-0-0-08,600 -02,600 4,200 -0$15,400 $ Adjustment $ 1,250 2,800 900 9,100 -01,800 -0-01,600 $17,450

Medical expenses (see Note 1) State income taxes Personal property tax Real estate tax Interest on residence Interest (home equity) Investment interest Charitable contribution Employee expenses (Note 2) Totals NOTES (1) Medical expenses:

For regular income tax [$9,500 – (7.5% X $110,000)] For AMT [$9,500 – (10% X $110,000)] Positive adjustment (2) Unreimbursed employee expenses: Expenses 2% of AGI ($110,000) Deduction for regular income tax pp. 14-18 to 14-21 b.

$1,250 -0$1,250

$3,800 (2,200) $1,600

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. 14-18 to 14-21

51.

There are positive AMT adjustments of $4,750 for the standard deduction and $3,050 for the personal exemption. Alternative minimum taxable income is $207,800 ($82,000 taxable income + $118,000 preferences + $4,750 standard deduction + $3,050 exemption). Examples 24 and 25 and related discussion Emily’s percentage depletion deduction for regular income tax purposes is $21,000 ($140,000 income X 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

52.

Alternative Minimum Tax 53. Amos’s preference item for IDC is computed as shown below: IDC expensed in the year Less: IDC if amortized over 10 years Excess IDC Less: 65% of $60,000 net income from oil and gas IDC preference p. 14-22 54.

14-19

$70,000 (7,000) $63,000 (39,000) $24,000

$9,000 interest on private activity bonds + $35,000 bargain element on incentive stock options + $4,750 standard deduction + $3,050 personal exemption = $51,800. pp. 14-14, 14-21, and 14-23 Pat’s tentative AMT for 2003 is computed as shown below: Taxable income computation Salary Interest and dividend income Gambling income Adjusted gross income Itemized deductions: Medical expenses ($12,000 – $7,500) State income taxes Real estate taxes Mortgage interest on residence Investment interest expense Gambling losses (limited to gambling income) Total itemized deductions Personal exemption Taxable income $4,500 4,100 2,800 3,100 1,800 4,000 $ 90,000 6,000 4,000 $100,000

55.

(20,300) (3,050) $ 76,650 $ 76,650 2,500 4,100 2,800 3,050 $ 89,100 40,000 $129,100 (31,600) $ 97,500 X .26 $ 25,350

Tentative minimum tax computation Taxable income Plus adjustments: Medical expenses Regular income tax [$12,000 – (7.5% X $100,000) = $4,500] AMT [$12,000 – (10% X $100,000) = $2,000] State income taxes Real estate taxes Personal exemption Subtotal Plus: Preference (interest on private activity bonds) Alternative minimum taxable income (AMTI) Exemption [$35,750 – 25%($129,100 – $112,500)] AMT base AMT rate Tentative AMT pp. 14-18 to 14-22

14-20 56.

2004 Comprehensive Volume/Solutions Manual Based on the amount of Ronald’s standard deduction and number of personal and dependency exemptions, Ronald’s filing status is head of household. Therefore, Ronald’s regular income tax liability is $21,987 [$21,462 + 30%($100,000 – $98,250)]. Ronald’s AMT is calculated as follows: Taxable income Adjustments ($7,000 + $6,100) Preferences AMTI Exemption [$35,750 – 25%($173,100 – $112,500)] AMT base Rate Tentative AMT Regular income tax liability AMT pp. 14-3 to 14-10, 14-21, and Figure 14-2 $100,000 13,100 60,000 $173,100 (20,600) $152,500 X 26% $ 39,650 (21,987) $ 17,663

57.

a.

Computation of Tara’s items of AMT adjustments and preferences for 2003: Incentive stock option adjustment $ 45,000 Excess depreciation on equipment preference ($41,000 – $26,000) 15,000 Percentage depletion in excess of property’s adjusted basis preference 50,000 Standard deduction adjustment 4,750 Personal exemption adjustment 3,050 Total adjustments and preferences $117,800 pp. 14-12, 14-14, 14-21, and 14-22

b.

Calculation of alternative minimum tax: Taxable income Adjustments and preferences Alternative minimum taxable income (AMTI) Less: Exemption amount (Note 1) Alternative minimum tax base Tentative minimum tax (Note 2) Less: Regular income tax on $121,000 Alternative minimum tax Regular income tax calculation Tax on $121,000: On $68,800 On ($121,000 – $68,800) at 30% Total tax Notes (1) Exemption phase-out: ($238,800 – $112,500) X .25 = $31,575; then $35,750 – $31,575 = $4,175 exemption amount. pp. 14-8 and 14-9 $ 14,868 15,660 $ 30,528 $121,000 117,800 $238,800 (4,175) $234,625 $ 62,195 (30,528) $ 31,667

Alternative Minimum Tax (2) AMT tax calculations: $175,000 X 26% ($234,625 – $175,000) X 28% Tentative minimum tax

14-21

$45,500 16,695 $62,195

Concept Summary 14-1 and Examples 24 and 25 58. Gross income: Salary Interest from bank Interest on corporate bonds Dividends Short-term capital gain Less: Deductions for AGI Adjusted gross income Less: Deductions from AGI Itemized deductions (Note 1) Personal exemptions (Note 5) Taxable income Regular income tax calculation Tax on $133,997: On $68,800 On $133,997 – $68,800 at 30% Total tax Computation of alternative minimum tax: Taxable income Plus adjustments and preferences: Itemized deductions (Note 6) Personal exemption Preferences Cutback adjustment Alternative minimum taxable income Less: Exemption [phaseout (Note 7): AMTI exceeds $255,500] AMT base Tentative AMT (Note 8) Less: Regular income tax Alternative minimum tax Notes (1) Because Larry’s AGI exceeds $139,500, Category A itemized deductions are those subject to the cutback adjustment (i.e., subject to the 3% of AGI floor). p. 10-30 $133,997 17,285 2,318 116,000 (855) $268,745 (-0-) $268,745 $ 71,749 (34,427) $ 37,322 $ 14,868 19,559 $ 34,427 $135,000 12,000 7,000 6,000 8,000

$168,000 (-0-) $168,000 (34,003) $133,997

$ 31,685 2,318

14-22

2004 Comprehensive Volume/Solutions Manual

Category A Unreimbursed employee business expenses (Note 2) $ 640 State income taxes 6,500 Real property taxes 6,800 Mortgage interest 7,200 Totals $21,140 (a) (b) (c) (d) (2)

Category B Not subject to cutback adjustment: Medical expenses $11,400 Casualty loss (Note 4) -0$11,400

Determine 80% limitation: (80% X $21,140 Category A deductions = $16,912 maximum reduction). Determine 3% of the excess amount over the threshold: [3% X ($168,000 – $139,500) = $855]. Subtract from the Category A itemized deductions the lesser of the amounts determined in Step a. or b.: ($21,140 – $855 = $20,285). Add the amount determined in Step c. to the Category B itemized deductions: ($20,285 + $11,400 = $31,685 total itemized deductions). $4,000 (3,360) $ 640 $24,000 (12,600) $11,400 $ 7,900 (16,800) $ -0$3,050 (732) $2,318 $ 7,200 7,200 $14,400 $31,685 (14,400) $17,285

Unreimbursed employee expenses Less: 2% of $168,000 Deductible amount Total medical expenses Less: 7.5% of $168,000 Deductible amount Casualty loss ($20,000 decline – $12,000 insurance – $100 floor) Less: 10% of $168,000 AGI Deductible amount Personal exemption phaseout: Personal exemption amount AGI less threshold amount ($168,000 – $139,500) = $28,500 $28,500/$2,500 (rounded up) = 12 X 2% = 24% 24% X $3,050 = Personal exemption amount AMT itemized deductions: Mortgage interest Medical expenses [$24,000 – 10%($168,000)] Total Regular income tax itemized deductions (Note 1) Less: AMT itemized deductions Positive adjustment

(3)

(4)

(5)

(6)

Alternative Minimum Tax (7) AMT exemption phaseout: Exemption amount Less: Reduction [($268,745 – $112,500) X 25%] Exemption AMT tax calculation: $175,000 X 26% ($268,745 – $175,000) X 28% Tentative minimum tax

14-23

$35,750 (39,061) $ -0– $45,500 26,249 $71,749

(8)

pp. 14-18 to 14-22 59. AMT computation Taxable income Plus: Timing adjustments Plus: AMT exclusion items AMTI Minus: Exemption [$35,750 – .25($300,000 – $112,500)] AMT base Tentative AMT [.26($175,000) + .28($300,000 – $175,000)] Minus: Regular income tax liability AMT AMT without timing adjustments Taxable income Plus: AMT exclusion items AMTI Minus: Exemption [$35,750 – .25($100,000 – $112,500)] AMT base Tentative AMT (.26 X $64,250) Minus: Regular income tax liability AMT Credit carryover computation AMT Less: AMT without timing adjustments AMT credit carryover Examples 29 to 31 60. a. Aqua is first exempt from the AMT for 1998 (the first year for which the exemption is available) as a “small corporation.” Aqua is classified as a small corporation if (1) it had average annual gross receipts of $5 million or less for the three-year period beginning after December 31, 1993 and (2) it had average annual gross receipts for each subsequent three-year period of $7.5 million or less (i.e., 1995, 1996, and 1997 if the tax year is 1998; 1996, 1997, and 1998 if the tax year is 1999; 1997, 1998, and 1999 if the tax year is 2000; 1998, 1999, and 2000 if the tax year is 2001; 1999, 2000, and 2001 if the tax year is 2002; 2000, 2001, and 2002 if the tax year is 2003). For the three-year period which includes 1994, 1995, and 1996, Aqua had average annual gross receipts of: $ -0200,000 100,000 $300,000 (-0-) $300,000

$ 80,500 (-0-) $ 80,500 $ -0100,000 $100,000 (35,750) $ 64,250 $ 16,705 (-0-) $ 16,705 $ 80,500 (16,705) $ 63,795

14-24

2004 Comprehensive Volume/Solutions Manual

$4,800,000 + $5,300,000 + $4,600,000 = $4,900,000 3 years 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: $5,300,000 + $4,600,000 + $8,200,000 = $6,033,333 3 years 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 2003. 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. $4,600,000 + $8,200,000 + $8,500,000 = $7,100,000 3 years Likewise, Aqua’s average annual gross receipts for the three-year period consisting of 1997, 1998, and 1999 do not exceed $7.5 million. $8,200,000 + $8,500,000 + $5,200,000 = $7,300,000 3 years Likewise, Aqua’s average annual gross receipts for the three-year period consisting of 1998, 1999, and 2000 do not exceed $7.5 million. $8,500,000 + $5,200,000 +$8,000,000 = $7,233,333 3 years Likewise, Aqua’s average annual gross receipts for the three-year period consisting of 1999, 2000, and 2001 do not exceed $7.5 million. $5,200,000 + $8,000,000 + $6,000,000 = $6,400,000 3 years Finally, Aqua’s average annual gross receipts for the three-year period consisting of 2000, 2001, and 2002 do not exceed $7.5 million. $8,000,000 + $6,000,000 + $6,200,000 = $6,733,333 3 years pp. 14-29 61. ACE Less: Unadjusted AMTI Difference Rate Adjustment 2002 $4,000 (3,000) $1,000 X .75 $ 750 2003 $3,000 (2,000) $1,000 X .75 $ 750 2004 $2,000 (5,000) ($3,000) X .75 ($1,500)*

Alternative Minimum Tax

14-25

*$2,250 ($3,000 X .75) but limited to $750 + $750, or $1,500. Further, the unusable negative adjustment of $750 ($2,250 – $1,500) is lost forever. Concept Summary 14-2, Example 32, and related discussion 62. Quincy Corporation: AMTI Less: Exemption amount AMT base Rate Tentative AMT $150,000 (40,000) $110,000 X .20 $ 22,000

Note: In this case, there is no reduction in the exemption amount because AMTI does not exceed $150,000. Redland Corporation: Step 1 AMTI Less: Threshold amount for exemption Amount by which AMTI exceeds $150,000 Reduction rate Applicable reduction in exemption amount Step 2 Exemption amount Less: Reduction in exemption amount from Step 1 Applicable exemption amount AMTI Less: Applicable exemption amount from Step 2 AMT base Rate Tentative AMT

$160,000 (150,000) $ 10,000 X .25 $ 2,500 $ 40,000 (2,500) $ 37,500 $160,000 (37,500) $122,500 X .20 $ 24,500

Step 3

Tanzen Corporation: Step 1 AMTI Less: Threshold amount for exemption Amount by which AMTI exceeds $150,000 Reduction rate Applicable reduction in exemption amount Step 2 Exemption amount Less: Reduction in exemption amount from Step 1 Applicable exemption amount

$320,000 (150,000) $170,000 X .25 $ 42,500 $ 40,000 (42,500) $ -0-

14-26 Step 3

2004 Comprehensive Volume/Solutions Manual

AMTI Less: Applicable exemption amount from Step 2 AMT base Rate Tentative AMT

$320,000 (-0-) $320,000 X .20 $ 64,000

Note: In this case, the exemption amount is phased out entirely because AMTI exceeds $310,000. pp. 14-27 and 14-32 63. a. Tax on taxable income of $3,000,000: $3,000,000 X 34% = $1,020,000 b. Taxable income Adjustments and tax preferences: Depreciation for regular income tax on realty in excess of ADS straight-line Excess amortization of certified pollution control facilities Tax-exempt interest on private activity bonds Percentage depletion in excess of the property’s adjusted basis AMTI Less: Exemption (AMTI exceeds $310,000) Alternative minimum tax base AMT tax rate Tentative AMT ( no foreign tax credit) Tentative AMT Less: Regular income tax liability AMT $3,000,000 $150,000 450,000 30,000 60,000 690,000 $3,690,000 (-0-) $3,690,000 X .20 $ 738,000 $ 738,000 (1,020,000) $ -0-

c.

pp. 14-27 to 14-32 CUMULATIVE PROBLEMS 64. Regular income tax computation: Free housing (Note 1) Grocery allowance (Note 2) Short-term capital gain Dividend and interest income (Note 3) Lottery winnings Incentive stock option exercise (Note 4) Life insurance proceeds (Note 5) AGI before rental loss and alimony Real estate rental loss (Note 6) Alimony $ -013,000 38,000 37,000 10,000 -0-0$98,000 (25,000) (24,000)

Alternative Minimum Tax Adjusted gross income Itemized deductions: Charitable contribution (Note 7) $5,200 Consumer interest (Note 8) -0State and local income taxes 4,600 Medical expenses [$7,500 – (7.5% X $49,000 AGI)](Note 9) 3,825 Gambling losses (Note 10) 8,000 Miscellaneous itemized deductions (Note 11) -0Personal exemption Taxable income Income tax on $24,325 (Note 12) AMT computation: Taxable income Adjustments and preferences: Incentive stock option adjustment $50,000 State and local income taxes 4,600 Medical expenses (Note 13) 1,225 Personal exemption 3,050 Interest on private activity bonds 40,000 Total adjustments and preferences Alternative minimum taxable income Less: AMT exemption [$35,750 – 25%($123,200 – $112,500)] AMT base AMT rate Tentative AMT Less: Regular income tax AMT 2003 Tax Liability Regular income tax liability Alternative minimum tax Total tax liability Note 1

14-27 $49,000

(21,625) (3,050) $24,325 $ 3,349

$ 24,325

98,875 $123,200 (33,075) $ 90,125 X .26 $ 23,433 (3,349) $ 20,084 $ 3,349 20,084 $23,433

Because Ron is a minister of the gospel, he can exclude the fair rental value of the parsonage of $2,000 per month. Note 2 The grocery allowance of $250 per week does not qualify for the § 119 meal exclusion. Note 3 The $40,000 of interest on private activity bonds is excludible from gross income. Note 4 The spread on the ISO of $50,000 ($70,000 – $20,000) is not recognized in 2003.

14-28 Note 5

2004 Comprehensive Volume/Solutions Manual

The life insurance proceeds of $500,000 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. 10-23 Note 7 Because the holding period of the stock is long-term and the stock is an intangible asset, the full fair market value of $3,200 qualifies for the charitable contribution deduction. The $2,000 he gave to the church from the lottery also qualifies. Note 8 The $3,700 of consumer interest cannot be deducted. Note 9 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 10 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 $10,000. Note 11 Miscellaneous itemized deductions are deductible only to the extent they exceed 2% of AGI ($49,000 X 2% = $980). The $200 for the safe deposit box rental is classified as a miscellaneous itemized deduction. Since the $200 is less than the $980, none of it can be deducted. Note 12 Tax on $6,000 15% X ($24,325 – $6,000) Note 13 Regular income tax medical deduction AMT medical deduction Medical deduction positive adjustment * $7,500 – (10% X $49,000) = $2,600 medical deduction. $3,825 (2,600)* $1,225 $ 600 2,749 $3,349

Alternative Minimum Tax 65. Robert and Jane have taxable income for 2002 as follows: Salary for Robert (Indiana Foundry, Inc.) Salary for Jane (Carmel Computer Associates) Interest income (Carmel National Bank) (Note 1) Dividend income (Able Computer Corporation) Gambling income (Note 2) Award income (Note 3) Capital gain (Note 4) Adjusted gross income Deductions from AGI Itemized deductions: Medical expenses [$19,725 – 7.5% X $229,800 AGI)] State income tax ($3,970 + $4,710) Real property tax on personal residence Mortgage interest on personal residence Investment interest expense Contributions ($11,000 + $2,000) Gambling losses (Note 2) Subtotal Minus: reduction under 3% cutback adjustment (Note 5) Total itemized deductions Exemptions (Note 6) Taxable income $ 2,490 8,680 4,600 7,500 1,900 13,000 4,000 $42,170 (2,775)

14-29

$ 89,000 102,000 3,300 3,500 4,000 15,000 13,000 $229,800

(39,395) (9,600) $180,805

Alternative minimum tax for Robert and Jane is computed as shown below. Taxable income plus exemptions ($180,805 + $9,600) Reduction caused by 3% cutback adjustment for itemized deductions (Note 5) Subtotal Adjustments: Medical expenses [$2,490 for regular income tax – $0 for AMT (Note 7)] Taxes ($8,680 state income tax + $4,600 real property tax) Total adjustment for itemized deductions Preference: Interest on private activity bonds Alternative minimum taxable income (AMIT) Less: Exemption (Note 8) Alternative minimum tax base Less: Amount eligible for alternative tax on net capital gain AMT base subject to ordinary tax rates $190,405 (2,775) $187,630

$ 2,490 13,280 15,770 30,200 $233,600 (28,100) $205,500 (13,000) $192,500

14-30

2004 Comprehensive Volume/Solutions Manual Tentative AMT liability on $192,500 (Note 12) Tentative AMT liability on $13,000 (Note 13) Tentative AMT Less: Regular income tax liability (Note 9) AMT Note 1 – excludible interest income The Carmel Sanitation District Bonds interest income of $30,200 is excluded from gross income. Note 2– gambling income and losses Since their gambling losses of $5,750 exceed the gambling income of $4,000, the excess loss of $1,750 is disallowed. The $4,000 of gambling income is included in gross income and the allowed $4,000 of gambling losses are classified as an itemized deduction. Note 3 – award received The $15,000 that Jane received for the “Citizen of the Year” is included in her gross income. Note 4 – sale of land Robert’s adjusted basis for the land he purchases is $67,000. So his recognized gain on the sale of the land is $13,000 ($80,000 amount realized – $67,000 adjusted basis). Robert’s holding period is long term. The gain is classified as long-term capital gain and is eligible for the alternative tax rate. Note 5 - 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. Medical expenses [$19,725 – (7.5% X $229,800 AGI)] State income tax Real property tax on personal residence Mortgage interest on personal residence Investment interest expense Contributions Gambling losses Total itemized deductions Medical expenses [$19,725 – (7.5% X $229,800 AGI)] Investment interest expense Gambling losses Total of itemized deductions not subject to reduction Itemized deductions subject to reduction 80% of $33,780 = maximum cutback adjustment AGI Less: Threshold for married, joint return Excess AGI 3% of $92,500 excess AGI $ 2,490 8,680 4,600 7,500 1,900 13,000 4,000 $42,170 $50,400 2,600 $53,000 (43,352) $ 9,648

$2,490 1,900 4,000

(8,390) $33,780 $27,024

$229,800 (137,300) $ 92,500

$ 2,775

Alternative Minimum Tax Reduction (smaller of $27,024 or $2,775) Note 6 – dependency deductions and phaseout

14-31 $ 2,775

Robert and Jane qualify for four personal and dependency exemptions. The two dependency deductions are for the twins, Ellen and Sean. They do not qualify for a dependency deduction for Robert’s daughter, Amy, even though Robert provides over 50% of her support. Margaret, Robert’s former wife, is the custodial parent, and she does not furnish Robert with a signed Form 8332. $3,000 X 4 = $12,000 However, because Robert and Jane’s AGI exceeds the threshold amount, the personal and dependency exemptions are subject to the phaseout provision. AGI Less: Threshold amount Excess Divided by $2,500 = Round to X 2% = Phaseout percentage Amount of phaseout ($12,000 X 20%) Personal and dependency exemptions Less: Phaseout Deductible personal and dependency exemptions Note 7 - AMT medical deduction $229,800 X 10% = $22,980 $19,725 – $22,980 = $0 medical deduction for AMT. Note 8 - alternative minimum tax exemption The AMT exemption phase-out for a married couple filing jointly applies if alternative minimum taxable income (AMTI) exceeds $150,000. The Armstrong’s have AMTI of $233,600, so the $49,000 exemption is reduced as follows: AMTI Less: Threshold Excess X 25% Amount of phaseout Exemption amount Less: Amount of phaseout Deductible exemption amount $233,600 (150,000) $ 83,600 X 25% $ 20,900 $ 49,000 (20,900) $ 28,100 $229,800 (206,000) $ 23,800 9.52% 10% 20% $ 2,400 $12,000 (2,400) $ 9,600

14-32

2004 Comprehensive Volume/Solutions Manual Note 9 - regular income tax liability Taxable income Tax on $171,950 35% X ($180,805 – $171,950) $180,805 $ 41,996 3,099 $ 45,095

However, since the $13,000 long-term capital gain on the sale of the land is eligible for the alternative tax on net capital gain, Robert and Jane’s regular income tax liability is $43,352 rather than the $45,095 calculated above. Tax on $167,805 ($180,805 – $13,000): Tax on $112,850 30% X ($167,805 – $112,850) Plus: Tax on net capital gain of $13,000: $13,000 X 20% Note 10 – holding period for the land Robert’s holding period begins on March 15, 1997. Note 11 – Jane’s inheritance The $600,000 that Jane inherited from her grandfather is excluded from Jane’s gross income. Note 12 – tentative AMT liability on AMT base subject to ordinary tax rates $175,000 X 26% = 17,500 X 28% = $192,500 $45,500 4,900 $50,400 $24,266 16,486 $40,752 2,600 $43,352

Note 13 – tentative AMT liability on AMT base eligible for alternative tax on net capital gain The $13,000 amount that qualifies for the alternative tax treatment for regular income tax purposes also qualifies for alternative tax treatment for AMT purposes. $13,000 X 20% = Note 14 – child tax credit The twins, Ellen and Sean, satisfy the statutory requirements for the child tax credit. However, Robert and Jane’s AGI of $229,800 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 p. 14-34 of the Solutions Manual. $2,600

Alternative Minimum Tax Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040 April 2, 2003 Mr. and Mrs. Robert Armstrong 1802 College Avenue Carmel, IN 46302 Dear Bob and Jane:

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Your 2002 income tax return is enclosed and indicates that you have a refund of $2,000 ($53,000 tax liability – $55,000 withholdings). Because the Carmel Sanitation District bonds are private activity bonds subject to the alternative minimum tax, $9,648 of the total tax owed is due to the alternative 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 minimum tax. If you have any questions, please call me. Sincerely, John Jones, CPA Partner

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2004 Comprehensive Volume/Solutions Manual NOTES

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