Cape Blue

AAAAARGH!

God I hate the US tax system, just when you think you have a sensible understanding of it you get another kick in the nuts .

So, I live in CA and 97% of my income is earned from salary/bonus (circa 3% from UK letting flat). I set up with my employer zero exemptions/allowances on both federal and state (I rent and have no kids) and expect to get a small rebate each year (and have done in the past).

My accountant now tells me I have fallen foul of AMT, and despite taking zero allowances, I am going to have to fork-out $15K for the 2010 tax-bill. Not $500 or $1,000, but $15-bloody-K!

I actually have no problem paying taxes (although tend to feel that one gets less for ones money in the US), but it can't be beyond the wit of man to devise a PAYE-type system that actually works, rather than getting socking-great surprises at the end of the year. Ahh, the good old days of PAYE.

And yes, I know, at least I have a job and it pays OK etc etc, it would just be nice not to walk-in expecting a $500 rebate, to be faced with a $15K bill.

I think I might have to invest in some Brit choc tomorrow.

Moan over, as you were.

Michael

Change you tax accountant or you aren't telling us something. The only thing that could possibly cause you owing more taxes is your bonus and that has nothing to do with AMT but instead with the fact that bonuses and exercised stock options are normally withheld at a flat 25% and it is possible that your upper marginal tax bracket is 28%, 33%, or 35%. Therefore you could possibly have 3%-10% too little withheld of your bonus. Also since you didn't have any tax withheld for your rental income, that will be taxed at your upper marginal tax bracket (foreign tax credit can be used to offset that income). Those incomes are taxed at your upper marginal tax rate because you normal salary had withholdings based on your deductions and exemptions (0% marginal tax bracket) and all the lower tax brackets. So if your upper marginal tax bracket is 28% (single incomes to $180,000 and married incomes to $225,000) and you had a bonus of $20,000 and rental income of $10,000, you will owe an additional $3,400 in federal income taxes ($20,000 * 3% + $10,000 * 28%).

As far as AMT, there is a $47,450 exclusion if single or $72,450 if married filing jointly. The way it basically works is that you take your total income, subtract your exclusion and multiply the remainder by 26% and this gives you the minimum tax that you must pay but only up to a maximum amount based on you deductions and exemptions. It is slightly more complicated than that but that will be used as a basis. Therefore if you don't itemize deductions, have little capital gains or qualified dividends AMT won't come into play.

There is a maximum amount of additional AMT tax that you would ever have to pay if you do not itemize deductions. That amount is 26% (28% for income above approximately $200,000) of the standard deduction plus exemptions. For a single person, that is $9,250 * 26% or $2,431 and for a married that is $18,550 * 26% or $4,862. If you itemize deductions, that amount is 26% of the deductions plus exemptions. In other words, AMT only gets rid of your deductions and exemptions and after that, you are taxed without AMT coming into play.

Example:

Income: $150,000
Bonus: $20,000
Rental Income: $10,000
Total Income: $180,000
Tax owed for a single person without itemizing deductions: $41,491
AMT for single person $132,550 @ 26%: $34,463
Tax owed for married couple filing jointly without itemizing deductions: $33,408
AMT for married person $107,550 @26%: $27,963
Therefore you pay your normal tax since AMT is less.

http://www.dinkytown.net/java/Tax1040.html

Last year the fortune 400 top billionaires only paid an effective federal income tax rate of 16.6%. This is because the vast majority of their income was long term gains or qualified dividends which is taxed at 15% and after AMT gets rid of all their deductions and exemptions, they are taxed at 15% for the remainder of their unearned income. Therefore 1/10th of their income (earned income, rental income, short term capital gains, non qualified dividends, and interest) may be taxed at 35% and the remainder is taxed at 15% for an effective tax rate of 17%. Approximately 99% of the billionaires also claim their primary residence in a state without state income tax (usually different than where he works) so that he doesn't have to pay state income tax on capital gains, dividends, and interest there by effectively having a total effective tax rate below 20% since FICA, gas tax, property tax, and excise tax contributes very little to his total tax burden.

If you pay foreign taxes, that tax credit is deducted from the tax owed after AMT is calculated.

Cape Blue

Thanks for taking the time Michael,

My UK property made around $10K profit before any depreciation allowance - the 27.5 years thingy on a mid-range value UK house should remove any tax liability for this (as far as I understand).

I just checked my bonus payment and the Federal + California tax withholding was 32.56%, my normal paycheck seems to have a Fed + CA withholding of 33.6%. There were some stock options and they were withheld (in fact some were automatically sold to cover tax) at 35.2% (Fed+State+FICA).

I am meeting my accountant later today to discuss. She had mentioned AMT over the phone.

Michael

You just ignore FICA since it doesn't relate to federal and state income taxes. The social security portion stops being paid when $6,621.60 has been withheld ($4,485.60 for 2011). The only time that you may get a tax credit for social security taxes paid is when you change employers or possibly subsidiaries of a company during the year (each employer or subsidiary could possibly withhold up to $6,621.60 therefore possibly giving you a $6,621.60 tax credit). You should never pay more that $6,621.60 in social security tax in any one year but the 1.65% medicare tax is based on you full earned when you file taxesincome.

Your withholdings for your normal paycheck is based on all your deductions, exemptions, and lower marginal tax brackets and the tax is based on each paycheck but spread over the complete year. Therefore each paycheck contains part of the deduction, exemption, and lower marginal tax brackets.

The only way to determine what is happening is break out federal and state taxes withheld separately. I suspect the issue is that you received a large bonus and/or exercised a large amount of stock options and therefore ended up not paying enough taxes.

When I exercised my stock options in 1999 (very large amount), I changed my W-4 to withhold an additional large amount of taxes for the remaining part of the year. My paychecks were very small during the end of the year.

When you are getting bonuses and/or stock options of $200,000 and your upper marginal tax bracket is 33%, that would cause about $14,000 too little to be withheld.

If you had a very large income and live in a state that has an income tax, I suspect your tax accountant didn't use the standard deduction since the amount of state taxes withheld (can be used as a deduction) would likely be greater than the standard deduction. This should only reduce your federal income taxes and AMT will not come into play since you don't have long term capital gains or qualified dividends to reduce your tax rate.

I don't think your rental property (even if the income is reduced to $0 due to depreciation) will affect AMT. That is because rental income is business income and depreciation is not a deduction that can be taken away by AMT. AMT does not look at how the business income was calculated.

At least you shouldn't get hit with any penalty for underpaying your taxes. That is because the government understands that people can get bonuses, exercise stocks options, or have large capital gains during any one year causing wide fluctuations in income and the law is written to not impose penalties in most cases.

Steerpike

Keep us posted please ... I got a bonus this year that was bigger than expected ... I'm hoping your accountant dropped a decimal point somewhere (I have yet to have a perfect return prepared by someone else - I always double-check and always find issues!).

Good luck!

Michael

Employee stock options are normally treated as earned income as soon the option is exercised and therefore tax is immediately due.

The exception is qualified employee stock options which are treated as long term capital gains (no FICA owed and a 15% tax rate) if held for at least one year after they are exercised. Qualified stock options are normally only available from private companies at a very low option price of $0.25, $0.50, or $1.00 per share. The tax law gives an advantage for qualified stock options since the company may never go public making the stock worthless. Generally when a public company purchases a private company, the employee qualified stock option must be exercised but can still be held for a year or more so the gain will be treated as long term capital gains.

Steerpike

Any update on this, Cape Blue? Was the issue valid or a mistake?

Cape Blue

It was, unfortunately, valid (or as far as I can tell) and down to me hitting the AMT levels.

My UK letting actually produces a loss after depreciation, so it is entirely down to my US salary/bonus earnings (good bonus year).

Looking at my W2, and after pension contributions, we have.

Fed 24.53%
CA 9.25%
SS 2.28%
SUI/SDI 0.35%
Medicare 1.53%
Total 37.94% - which wasn't enough, hence I had a Fed shortfall, but a small State overage, bringing the percentages to:

Fed 29.93%
CA 8.90%
SS 2.28%
SUI 0.35%
Medi 1.53%
Total 42.99%

http://en.wikipedia.org/wiki/Alternative_Minimum_Tax

Michael

Did you get hit with AMT? Your write off for your UK property should have had a positive effect when calculating AMT since that would have been reported on Schedule E which would have reduced your reported income.

Cape Blue

My UK write-off was only around $4k, so yes, I did get hit with AMT.

Michael

How much AMT did you get hit with? I don't understand how you could have gotten hit with AMT with the information that you posted. With that information, all the additional income should have been calculated as normal income probably at a 33% tax rate.

AMT is what is reported on line 45 of IRS form 1040.

Cape Blue

As you can see from my table on the other post, before I did my return my fed tax rate (after pension payments) was 24.53% on my W2. The AMT brought this up to 29.93% of post-pension income (I have zero exemption AMT) which equated to a smidge over 28% of gross (without pension contributions removed) - 28% being the AMT rate.

Michael

That means nothing other than part of your income was taxed at 0%, 10%, 15%, 25%, 28%, and likely 33% which are the different marginal tax brackets and your bonus and exercised stock options likely only had 25% withheld (required by law unless the employee asks to have more withheld) instead of the 33% that extra income likely would be taxed at. You probably didn't get hit with the highest 35% marginal tax bracket unless you made over about $400,000.

AMT (Alternate Minimum Tax) are taxes in addition to the tax from the marginal tax brackets and the only way to know if you paid AMT is to check line 45 of form 1040.

The UK also has marginal tax brackets. In 2008 there were two marginal tax brackets of 20% and 40%. After allowances you would pay 20% tax on the first £34,800 of your income and 40% tax on everything after that. So if you made £69,600 after allowances, you would pay £6,960 tax on your first £34,800 and £13,920 tax on the second £34,800. Currently the UK has 4 marginal tax brackets of 10%, 20%, 40%, and 50%. The biggest change from 2008 was that incomes over £150,000 would be taxed at 50% and people with very low incomes (first £2,560) would be taxed at 10%.

http://www.scopulus.co.uk/taxsheets/default.htm

As more tax brackets become available it becomes more difficult for the government to correctly withhold the right amount of taxes if a person receives overtime, bonuses, exercised stock options, a person doesn't work 12 months during a year, or holds multiple jobs since the tax brackets are based on a estimated yearly salary and not specific pay received during a week or month. Since the current UK 10% bracket covers a very low income, it will be quite easy for a person to move from the 10% marginal tax bracket to the 20% marginal with just one check for overtime moving that person into the 20% bracket but would likely move all of his income back to the 10% bracket if he got laid off.

Cape Blue

Sorry Michael, but I have no idea what you are talking about, perhaps I haven't explained clearly. I know I paid AMT - my accountant told me that was the case, I can see it on the line 45.

The UK marginal tax rates have nothing to do with my US return (as I mentioned my, UK letting was a small loss for IRS purposes).

The percentages I posted from my W2 are clearly the total percentages withheld from my salary/bonus and take into account the all marginal rates (and allowances) on the way up.

The second list of percentages are the percentages after AMT was applied and the Fed at 29.93% comes down to 28% when I add back-in my pension contributions.

AMT requires that I pay 28% federal with zero exemptions, hence the overall 24.53% Fed I had paid (after pension) is now moved up to 28% (ignoring pension contributions), the difference between the two percentages being roughly the amount of extra AMT I had to pay.

Michael

So I guess you want to talk around in circles and not say how much is reported on line 45 of form 1040 and only quote what you tax accountant said.

Without that information, nothing you said has no bearing on whether AMT was paid.