A number of states have their own version of an Alternative Minimum Tax – one that is imposed at the state level, separate and distinct from the Federal Alternative Minimum Tax. While a state AMT certainly adds to the burden of those subject to the Federal Alternative Minimum Tax, the proper implementation of tax planning opportunities in these situations can result in a double benefit to the taxpayer.

Federal AMT calculation

Many of the itemized deductions that are taken for the Regular Tax on an individual’s Form 1040 are adjustments that directly trigger the Federal AMT. Chief among these is the deduction for state taxes, the biggest part of which is state income taxes. The consequences of high state income taxes are easy to see – the more state income tax paid the more AMT that will be paid at the Federal level. This is why individuals in high income tax states such as New York and California are among the leaders in Federal AMT paid.

States with an AMT

Speaking of New York and California, these are the two leading jurisdictions with a state level Alternative Minimum Tax. This is on top of these states’ Regular income tax rates, which already are among the highest in the nation. For example, the highest marginal Regular Tax rate for New York (not even including New York City) is 8.97 percent, and for California it is 9.3 percent (10.3 percent for those making over $1 million). As if these weren’t high enough, taxpayers with AMT items will end up paying tax rates effectively even higher than these.

Computation of the state Alternative Minimum Tax

Not surprisingly, both California and New York structure their own AMT by following, at least in part, the Federal rules with regard to AMT items as shown on Form 6251. Thus, for example, if a taxpayer in one of these states has an AMT item resulting from depreciation, depletion, intangible drilling costs or small business stock, these will also factor into computing the state Alternative Minimum Tax. But each also state has its differences from Federal, so an AMT payer must be careful to take note of these differences. For example, private activity bond interest is reported in computing New York’s but not California’s. To the contrary, AMT adjustments for itemized deductions are reported in California but not New York.

Planning to reduce the state AMT

To the extent a Federal AMT item also affects an individual’s state AMT, the tax planning strategy is the same for both. For example, an election to use straight-line depreciation instead of accelerated depreciation on property used in a business or held for investment will reduce the Alternative Minimum Tax both at the state as well as at the Federal level. In California, where itemized deductions trigger the AMT, careful planning for the timing of the payment of real estate taxes can reduce the California AMT as well as the Federal. Note also that California picks up the Federal adjustment for Incentive Stock Options (ISOs), so proper planning for these can in many cases result in the taxpayer’s totally avoiding paying the Alternative Minimum Tax.

Effect of planning on the combined Federal and state AMT burden

The added significance to AMT planning for individuals in jurisdictions with a state AMT is the compounded savings that can be achieved. For example, the highest Federal AMT rate is 28 percent, and the California AMT rate is 7.25 percent, while in New York the AMT rate is 6 percent (plus another 2.85 percent for New York City residents). Therefore, moving an AMT item from a year the taxpayer is stuck in the AMT to a year the individual is paying the Regular Tax could have a tax savings benefit of over 35 percent.

Conclusion

Of the four million individuals paying the Federal AMT, a significant number live in states that also have a state level Alternative Minimum Tax. AMT planning in general always will yield tax savings; for individuals living in these AMT states the planning is even more valuable in terms of actual tax dollars that can be saved.