Chapter 12, Problem 1DQ

Kelly was promoted and received a substantial raise that includes compensation in the form of incentive stock options. She talks to her tax adviser about potential tax ramifications. After making some projections, her adviser welcomes her to the AMT club. Kelly is surprised to learn that her promotion will be rewarded with an additional tax in the form of the AMT. Explain to Kelly the purpose of the AMT and why it applies to her.

To determine

Explain the purpose of AMT and its application in Mrs K’s case.

Explanation of Solution

Alternative Minimum Tax (AMT): AMT is a tax system imposed by congress to collect a minimum amount of income tax for each year from the taxpayers who generated the income more than modest economics income. The AMT uses economic income as the tax base rather than the regular income tax base.

Purpose of AMT

• When the tax payer is uses alternate minimum tax, exclusions, deductions, and credits are used. This helps to reduce and eliminate the regular income tax liability of the tax payer.
• Secondly, Congress, the legislative body of Country U has a belief that some of the taxpayers who have substantial economic income take too much advantage of the minimization of the taxes and thus resulted in more inequality.

Thus, above two are the major reasons for enacting AMT.

Application of AMT

• Primarily, AMT was initiated to make sure that taxpayers who have uncertain economic income must also pay minimum tax.  In the given case, K receives taxable income plus adjustments and preferences. She pays more state tax and has other investment alternatives. This results AMT consequences and thus, gets benefited out of the advantaged stock option compensation. Hence, K will incur AMT.