Definition§
A Tax Preference Item is an income or deduction that might be excluded or partially excluded from regular income tax calculations but must be included for the purpose of calculating the Alternative Minimum Tax (AMT). The AMT is designed to ensure that individuals and corporations that benefit from certain exclusions, deductions, and credits still pay a minimum level of tax.
Examples§
Example 1: Municipal Bond Interest§
Interest from private activity municipal bonds is typically exempt from regular federal income tax, but it is considered a tax preference item and must be added back when calculating AMT.
Example 2: Accelerated Depreciation§
Accelerated depreciation on certain property types used for tax purposes can provide significant immediate tax savings. For AMT calculations, this depreciation is often recalculated using a different depreciation schedule, often resulting in a higher taxable income.
Example 3: Mining Exploration and Development Costs§
Mining exploration and development costs may be expensed for regular tax purposes. However, these costs can be adjusted back into income for AMT calculations if they exceed the allowable AMT depreciation limits.
Frequently Asked Questions§
What is the purpose of Tax Preference Items?§
Tax Preference Items are used primarily to calculate the AMT, ensuring that taxpayers who benefit from certain deductions and exclusions still pay a fair amount of tax.
How does the AMT impact individual taxpayers?§
The AMT recalculates taxable income by adding back certain deductions and exclusions (tax preference items), often resulting in a higher taxable income and tax liability for some taxpayers.
Who needs to be concerned about Tax Preference Items?§
Both individual taxpayers and corporations who benefit from significant exclusions or deductions in their regular tax calculations need to be aware of tax preference items and their potential impact on AMT liability.
How are Tax Preference Items reported?§
Tax Preference Items are reported on IRS Form 6251 for individuals and on IRS Form 4626 for corporations. These forms help calculate the AMT by adjusting the taxpayer’s income with specific tax preference items.
Can you avoid AMT by planning around Tax Preference Items?§
Effective tax planning can minimize AMT exposure, but it often requires detailed forecasting and understanding of both regular and alternative tax systems. Consulting with a tax professional for AMT planning is advisable.
Related Terms§
Alternative Minimum Tax (AMT)§
A parallel tax system designed to ensure that taxpayers who receive certain deductions and exemptions pay at least a minimum amount of tax.
Depreciation Recapture§
The gain realized upon the sale of depreciated property, which is subject to ordinary income tax rates rather than capital gains rates.
Private Activity Bonds§
Municipal bonds issued to finance projects for private enterprises. The interest on these bonds may be subject to AMT.
Minimum Tax Credit (MTC)§
A tax credit available to taxpayers who paid AMT in prior years. This credit can offset regular tax in future years to the extent that regular tax exceeds AMT.
Online References§
Suggested Books for Further Study§
- The Tax Law of Private Foundations, 2023 Cumulative Supplement by Bruce R. Hopkins
- J.K. Lasser’s Your Income Tax 2023: For Preparing Your 2022 Tax Return by J.K. Lasser Institute
- Tax Planning and Compliance for Tax-Exempt Organizations: Rules, Checklists, Procedures 2023 by Jody Blazek
- Alternative Minimum Tax: What You Need to Know, including recent legal changes by Steuerdepot Finanz
Fundamentals of Tax Preference Items: Taxation Basics Quiz§
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