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Chris Paris, partner in charge of the Moss Adams office in Santa Rosa, discussed the alternative minimum tax.

The AMT, launched by Congress in 1969, is a parallel tax system intended to make people with high incomes pay at least a fair minimum tax, even if they had deductions that sharply reduced or even eliminated their taxes under regular filing guidelines.

Under the 2016 AMT, exemption amounts are $53,900 for single taxpayers, $83,800 for married taxpayers who file jointly and $41,900 for married taxpayers who pay separately. The AMT, which can hit many business owners especially when they sell a business, is calculated on Form 6251 and can result in thousands of dollars of additional taxes.

Where does the alternative-minimum tax affect businesses the most?

CHRIS PARIS: The primary area where we see it the most is a lot of business owners hold their business through flow-through entities such as an S corporation or LLC. All the income that flows through from those entities goes to them personally as the business owner.

The big issue is high state income taxes, such as in California and New York.

How does the AMT hit business owners subject to high California state taxes?

PARIS: You don’t get the benefit of being able to deduct state income taxes (with the AMT). That’s the major issue we see with business owners.

That kicks them into the AMT?

PARIS: It frequently does, yes. With many middle-market clients, the business owners are in AMT because of income flowing through from the business. They don’t get the benefit of deducting state income taxes.

For such folks to avoid the AMT, they need to go back to the underlying business and increase expenses to the business?

PARIS: Exactly. Use advantageous accounting methods. Accelerate depreciation deductions. Accelerate prepaid expense deductions. Defer income to the extent possible. Closely monitor whether you are going to be in AMT every year. In November or December, run tax projections to determine if you’re in AMT or not.

If the subsequent year is going to have a lot less income or a lot more income where you blow through AMT, defer paying California state income taxes until the subsequent tax year.

If the business owner is not going to be in AMT, what should s/he do?

PARIS: Pay everything possible in the current year because you’re getting the benefit of the deduction.

These business owners should do a Form 6251 every year?

PARIS: Yes. Do a Form 6251 and tax projections to monitor whether or not they’re going to be in AMT. If they’re not in AMT, they should pay everything.

If they are in AMT, they should delay payment of California state income taxes instead of paying it before year-end. Pay it next year, say on Jan. 1, and reevaluate everything next year. California state income taxes are the big thing. Property taxes are another that you don’t get the benefit of in AMT. Depreciation differences also affect AMT.

AMT does not allow these writeoffs?

PARIS: Exactly.

Does the AMT hit a lot more taxpayers now than it was intended for?

PARIS: Absolutely. The idea behind the alternative minimum tax is for certain taxpayers who are taking all these deductions and they have a bunch of tax-exempt income, but not exempt from AMT, we’re going to make those folks pay some sort of minimal tax amount so they can’t avoid paying income tax altogether. A lot of provisions in AMT haven’t been indexed for inflation.

You have this old system with a bunch of numbers that aren’t relevant in today’s dollars. Every year they talk about whether it’s going to be repealed. It snags more people every year. It’s very common for middle-market business owners to be in AMT. It’s well beyond its intended purpose in terms of the number of taxpayers now subject to AMT.

With Trump and his desire to reform taxes significantly, this is one of the things on the table. I wouldn’t be surprised if it’s eliminated. Toward the end of 2017 we’ll have a much better idea how the AMT is going to affect everybody going forward.

The typical income bracket at which the AMT kicks in is about $300,000 and above?

PARIS: That’s about right, $300,000 to $1.5 million. Then you start to blow through AMT, where your ordinary income-tax rate is higher than the alternative minimum tax. A very large percentage of our clients who have income between $300,000 and $1 million end up in AMT.

For people who have stock options as part of their compensation, is it common that the AMT kicks in when they exercise those options?

PARIS: It is. Incentive stock options are popular with startup tech companies. They have a strike price, and the value of the stock theoretically increases. When the employee buys that stock at a lower strike price (exercises the option), on the regular income side, it’s a non-event. Let’s say the strike price is $100 (a share) and now it’s worth $200. When you buy it for $100 for regular income-tax purposes, you have no issue.

As long as you still hold it and don’t sell the stock?

PARIS: As long as you’re still holding it. For AMT, when you exercise it, you have $100 of AMT income.

Whether you realize that gain or not?

PARIS: Even if you still hold the stock and haven’t sold it. That’s exactly right. For a lot of stock options, they will do same-day exercise and sell for that reason. Then you don’t have to deal with the complexities associated with the AMT income recognition.

But a lot of higher-level executives don’t do that, especially if they have been at tech companies for a long time and have many different buckets of stock options. They end up with a lot of differences on the income-recognition side in the AMT world in comparison to the regular-tax world.

Are most executive stock options annual?

PARIS: Usually it’s annually and they vest, as part of their overall compensation. The vesting component is usually four to five years. As they become vested, they’ll exercise those and move on to the next bucket. It works well in retention.

As those options accumulate, they end up with a huge potential tax liability?

PARIS: Yes.

In those situations, your recommendation is to exercise the options then sell immediately so the difference between strike price and market price is a realizable gain?

Many employers are well versed in this stuff and tell the employee if they exercise the options and hang on to the stock, they’re going to have AMT income but it doesn’t affect you tax-wise or things get more complicated. Or you could just do the same-day exercises and sell, then they include it in W-2 wages.

From a reporting perspective, it makes life a lot easier. We see a lot of clients opt for that, usually when they have a lot of options earlier on and haven’t been at the company a long time and have all these different buckets of options with different strike prices. Longer-term executives already realize that this complexity is part of their lives.

In some situations if the AMT is paid, can there be a minimum-tax credit in subsequent years?

PARIS: That is correct. There’s an AMT tax credit. If you can’t use it, you get to carry it forward. The idea is to make you whole. If you pay a minimum tax and then in a different year you have a different result, you get a credit for taxes you previously paid.

We don’t have many clients who are able to take advantage of minimum-tax-credit carry-forwards because of how the credit works. It’s there, but in reality doesn’t apply that frequently.

In what industries does the AMT hit business owners the most?

PARIS: It’s less about industry and more about income levels. For industries that have steady, recurring profitable income streams, it (AMT) affects business owners.

For other businesses that are more cyclical, such as real estate, with huge fluctuations in income, they’re less inclined to get hit with AMT. If you sell an asset in one year and then not the next, you may have AMT in one year but not the next.

The AMT less often applies to occasional high-earners?

PARIS: Exactly. For occasional high-earners, in the year when they are a high earner, one of two things happens. If they become a high earner but don’t blow through AMT, they have AMT that year but not again.

Or they have AMT but then have a huge income year because they sold big assets at a big gain, then they blow through AMT in that year and then go back to it. Ones that have cyclical profitability tend to move in and out of AMT depending on the year.

What is the general AMT tax rate?

PARIS: It’s a flat income-tax rate, unlike regular-tax graduated rates. It’s either 26 percent or 28 percent.

If a business owner is facing an AMT, are there things that owner can do beforehand so they are less subject to that tax?

It’s difficult to tax plan once you are in AMT.

You are sort of snared by it?

PARIS: You are kind of snared by it. The main thing you can control in AMT is tax-related payments, whether it’s state income taxes or property taxes. The other thing you can closely monitor is the timing of asset sales or portfolio sales. If you are going to have significant capital-gain income, you can largely control that from a timing perspective. Sell a stock portfolio or real estate this year or next year, for example.

If you’re going to be subject to AMT, you would defer those kinds of asset sales?

PARIS: Exactly. Or spread them out across multiple years. You can manage your AMT by the timing of your asset sales. There are also different accounting methods you can adopt that are advantageous for AMT purposes, but those are less applicable to all industries.

When a small-business owner sells the entire business, that often triggers the AMT?

PARIS: Yes. It frequently triggers the AMT. They may have an income stream where they’re falling below the AMT level then they sell their business and get pushed into the AMT.

On a lot of business sales, there’s contingent consideration where it’s an earn-out. The buyer of the business pays the seller X, but part of it is held back. The business has to retain key employees, has to maintain certain revenue levels, profitability levels or customer bases. Then the buyer pays the rest of the selling price.

You can plan for AMT a little bit there by negotiating the hold-back amount.

Holding back could actually benefit the business owner and get him or her out of AMT for a year or two?

PARIS: You could, yes. If you spread the income out over a longer period of time (AMT could be avoided).

The business owner who sells could do the same with a covenant not to compete?

PARIS: Absolutely.

For a business sale, what amount typically triggers the AMT?

PARIS: Most of our clients are selling for $3 million to hundreds of millions. A lot fall in the $10 million to $50 million range. On the higher end of that, you are likely going to blow through AMT.

On the lower end, if there’s an earn-out, there’s a high likelihood you’re going to be in AMT. If a sale is coming, we have a good idea of the amount of cash coming. We might have them prepay all their state income taxes or pay up to a certain level.

If they pay beyond that, they get no benefit from an AMT perspective. Then we have them pay the rest next year. We try to match payment of state income taxes with income coming in from the business sale.

You’ll do that late in the year before the business sale?

PARIS: Yes. We’ll run projections on the business sale.

Of your total client base in the North Bay, what portion are subject to the AMT?

PARIS: Probably 25 to 30 percent. We are dealing with this all the time.