 Hello, and welcome to this session. This is Professor Farhad in which we would look at the AMT, all the Alternative Minimum Tax, a topic that's dreaded by students and CPA candidate. This is part one of five. So in other words, I'm gonna have four subsequent sessions to this one. So you wanna make sure you build your knowledge step by step. And this is how I teach versus a CPA review course where they review the material with you. So what I'm gonna do, I'm gonna build your knowledge. What's an AMT starting slowly and build your knowledge up until you can solve easily a CPA simulation. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax, finance, as well as Excel tutorial. If you like my lectures, please like them, share them, put them in playlist. If they benefit you, it means they might benefit other people, connect with me on Instagram. On my website, farhadlectures.com, you will find additional material. For example, under my individual income tax course or intermediate accounting or auditing or tax or advanced accounting. If you're studying for your CPA exam, additional resources to help you succeed on the exam. So first I'm gonna introduce the basic idea of AMT. What is the, what's the idea of AMT? So I'm gonna give you two examples, two taxpayers as an example and show you why AMT exists. Let's assume taxpayer one, 22 years old. This individual studied accounting and they just graduated and they get a job offer for $50,000 and $50. They have some savings from their parents. They're earning interest of 150. Their total income is 50,200. Taxable income is their total income minus the standard deduction happens to be 12,200. Their single, their taxable income is 38,000. Now bear in mind that this individual, they work in a CPA firm. Once they watch farhad lectures and they pass the exam, their salary should go up to 65,000, right? Just by passing the exam. Now let's look at taxpayer two. Taxpayer two already has been established 35 years old, very successful individual. They work, they have a job and it's their company and they make 80,000 or they work for someone else, it doesn't matter. They had a lot of savings over the year and they have municipal interest of 10,000. Cash rental income, 15,000. They have a rental property and as a result they have income, cash rental income. It means they're generating cash income. It doesn't mean it's taxable because you will see later that you could generate cash rental but they could have tax deduction. They own two home, they pay interest in total 20,000 and they pay in total taxes 10,000. They gave the charity 8,000. They started the business and incurred 10,000 of losses and they have a tax deduction rental property of 25,000 because remember they have a rental property. So on paper they're losing because they have a large depreciation. So let's take a look at what's happening here. They have wages of 80,000. This 10,000 is not taxable. This cash rental income, it's not gonna be taxable because on tax basis they're losing. They own two homes, they're gonna be able to deduct 20 and 30,000 so they have a 30,000 of deductions, standard deduction. They have an additional 8,000 of charities. They started a small business, they generated 10,000 of losses and they have 25,000 in rental property losses, legal property losses. So simply put after all said and done, if you do the math, I believe taxable income should be 24,000. Therefore their taxable income is 24,000. So notice the amount of income this individual has versus this individual and you will notice they have taxable income less than this college students. So that's the purpose of AMT is to provide equitable distribution of tax burden. So they're 35 years old is paying less taxes, which is not fair. So what the government is saying is come back here, we gave you a lot of deductions. We need to talk to you again because you make so much money. So it's raising the tax without raising the tax. Basically the politician loved the AMT because you can say I did not raise the tax and what you do is you subject people to do different tax return. President Reagan was known for that because he said, read my lips, I'm not gonna be raising the taxes. He did not raise the taxes but the AMT was an indirect raise of taxes. So you could raise the tax, tax rate without raising the actual tax rate that people are aware of. So let's take a look technically of how the AMT work and start to kind of from a practical perspective, how does it work? There's a formula and here's how it works. And don't worry, we're gonna be working plenty of numbers shortly. You start with your regular taxable income. So you compute your regular taxable income and at this point, if you're studying AMT, it means you know how to compute your regular taxable income. Then you add back your standard deduction. If you took your standard deduction, you add it back. Then you have certain adjustments where we call them reconciling items. Those are sometimes pluses, sometimes minuses. We're gonna talk about them. Then you add something called preferences. We'll talk about preferences later on. And that's gonna give us alternative minimum taxable income before exemption. Then the government gives you an exemption. We'll talk about the exemption later on. It's subject to inflation. So it changes from year to year. We'll have a one whole session about exemption. And from that, we will compute alternative minimum taxable income base. We'll take this number, multiply it by either 26% or 28% depending on how much your number in the AMTI. And that differ from year to year. For example, 2020, I believe it's around 194,000 plus. Up to this amount, you pay 26%. Above that amount, you pay 28% less, 37.26. Then you get your tentative AMT before credit. Then you are allowed certain credit, especially the foreign credit. From that, you'll get your AMT tax, which is the AMT I add the word tax to tell you it's tax, but it's AMT is the tax. Then what you do is you compare your AMT to your regular tax. So if you paid 60,000 in your regular tax and your AMT end up to be 65, guess what? You're gonna have to pay an additional $5,000. You have to pay an additional $5,000. So let's start to take a look at these adjustments. So if it's standard reduction, it's easy, you add it back. So what are some adjustments? Well, let's start with schedule A. So if you have a lot of deductions on schedule A, they may take some of it. Now with the new tax cuts and jobs act, the AMT is not a big deal anymore, but we have to learn about it. So first, again, if you took the standard deduction, you have to add it back. What happened if you itemized? Well, if you itemized the following are allowed for AMT deduction. So the following are allowed, they're not allowing, are allowed for AMT deduction. So if you took your medical deduction, you could still take it for AMT. If you took your mortgage interest, you can still take it. Charity, you can take the charity. You can take any miscellaneous deduction if you did file for them. However, state and local tax deduction are added back. And simply put, the maximum you can deduct on your schedule A is 10,000 under the tax cuts and jobs act. So simply put, you might have to add back $10,000 of state and local deduction. Not a big deal. No, it's not a big deal anymore. Because this used to be for some people, 50,000, 75,000 for some people. If you own two homes and you make a lot of money, you're paying local and state taxes, you would have a large deduction. That's no longer the case. Even if you have those expenditure, you can only deduct 10,000. Ask President Trump about that, okay? Now, here's schedule A. So let's assume we're looking at this schedule A, this individual, and hopefully you're familiar with schedule A. They have medical expenses of 65,450. Notice taxes you paid, the maximum is 10,000. Interest paid, 15,400. Gift to charity, 12,800. Therefore, their total itemized deduction is 103,650. Here's what they can do. For regular tax, they can take the deduction. It doesn't apply for AMT. So they could take it for AMT. They don't need to make any adjustment. The taxes, they can deduct it for regular tax on schedule A. They cannot take it for the AMT. Therefore, the AMT is an adjustment. Mortgage interest, remember, you can take it for regular tax. You can take it for AMT. Cheerful contribution, you can take it for regular tax. You can take it for AMT. Simply put, after all said and done, basically you have to add back 10,000 to your AMT alternative minimum tax. Now, also you might have depreciation. If you have a business and you're depreciating asset, guess what? You're gonna be subject to different depreciation rule. Under regular tax, if you have a real property placed in service after 1986, but before 1999, for regular tax, you would use the straight line and you would use either 27.5 years for all rental property or 39 years for non-residential real property. That's what you do for regular basis. For AMT, you would still use the straight line. However, you would use 40 years for both assets. What happened is, it doesn't make a difference for the non-residential property. Simply put, the Congress said, don't worry about the 39 non-residential property. You don't have to make an adjustment for it, but you have to make an adjustment for the 27.5 rental residential because it makes a difference because what you do is you take that asset and you spread it over 40 years, your deduction goes down. So the government wants to charge you more in taxes. Any real property after 1998, there's no AMT adjustment. For personal property after 1986, but before 1999, you would use the 200 double declining balance. What you have to use, you have to use the 150 double declining balance. Simply put, they're gonna trim down your depreciation for rental residential and for personal property. That's basically what they're doing. That's simply put. So let's take a look at an example for commercial property to show you it's not a big deal for commercial property because under regular taxes, 39 years under AMT, it's 40. So one year it's not gonna make a difference. So let's assume Adam purchased a warehouse for 310,000 in August 1998. Regular depreciation AMT for 2019 is calculated as follow. So for 2019, the regular tax is 7,948. And hopefully you know how to do this. If you know how to do this, if you don't know how to calculate regular tax depreciation, go to my, just Google Farhad Depreciation or go to my YouTube at Google Farhad Depreciation or how to compute depreciation and you will find it. Specifically, I believe it's chapter six or seven in my income tax course. For AMT, you'll have to use 2.5. So simply put, the government said, if the difference is 198, just don't worry about it because the difference between those two is one year. So basically you're taking a 30 year property, turn it into a 40 year property. It's not gonna make that much of a difference. The government says, don't worry about it. So that's what we're saying. So you do have a different schedule for AMT real property. This is the AMT real property schedule and this is the AMT personal property. Here again, we did the computation just for illustration but don't worry about it. Let's assume the same building was an apartment building. Now, it makes a difference. Why? Because for regular tax, you are deducting depreciation based on a 27.5 year life for AMT, you're turning that into 40 years. So let's take a look at Adam, same property but now it's apartment building. For regular tax depreciation, Adam can take $11,275 in regular tax depreciation. For makers, I'm sorry, this is makers or type far hat makers somewhere and you will find this. For AMT, you multiply it by 2.5 and this is what I was trying to say about the schedule. Let me go back to the schedule. So what you do for the schedule, it's between year two and year 40, you multiply it by 2.5. So notice it does make a difference. Now you're talking about $3,525 difference. Now for large companies, add more zeros or individuals with a lot of property, you add more zeros to this. So the difference is substantial, that's the point. So let's assume Adam also had two depreciable business asset, like two pieces of furniture. AMT depreciated is computed based on 150 double declining versus the makers is 200 double declining. So let's take a look and compute the depreciation. So, and we are in year eight for this example. Simply put, we bought an asset in 2012. So the half year convention apply here. The half year convention apply here. It's a seven year life asset for makers. For makers, if you don't know how to compute this, again, Google makers far hat tax or something like that, 312 and 535. Now, if we go to the alternative minimum tax and we compute this based on the 155 declining balance, what's gonna happen is we're in year eight and the asset is a seven year property, therefore the rate is 6.13. So we'll take this 7,000 times 6.13, we'll get 429, we'll take 12,000 times 6.13 and we'll get 201. What happened here? The answers are negative. What does that mean? It means as far as AMT, now we have less, we have, I'm sorry, we have more deduction. So we have basically a negative adjustment, which is good as a negative adjustment, good as a negative adjustment. So take a look at this Excel sheet and the regular taxable income we're gonna assume is 154, 650, it's giving. The first thing we had to do is we had to add back $10,000 for the tax deducted on schedule. I remember we had to add it back because we took it for regular tax, we cannot take it for AMT. Then you guys remember we just computed the 198, one year difference and we said that's not taken. So you cannot take that 198 because Congress said it's too small. Don't worry about this adjustment. Here, what's gonna happen is we're gonna have to take the difference between the AMT and regular for the rental property. Remember we changed the example and we said let's assume it's a rental property. When it comes to a rental property, the life is longer, the difference is 27 and a half versus 40 years. Therefore the difference is 35, 25. And now we just saw that we had negative adjustments and the negative adjustment amounted to $318. Amounted to $318, so I'm gonna put this as negative adjustments. So negative adjustments are good. Why they are good? Because they are reducing your AMT for tax purposes. You are paying, simply you are paying less. That's basically what you are doing. So let me get out of here. Negative 318 and there we go, negative adjustment. Now obviously if we have different in the depreciation method, then if we sell an asset, we're gonna have a different in the amount of the gain and the amount of the loss. Why? Because if you have different adjusted basis, one for AMT and one for regular tax, you'll have difference in the gain and the loss. So let's suppose we purchase furniture on February 10, 2017 for 6,000. On March 2nd, 2019, we sold the furniture for 4,300. So let's compute the gain based on the 200 double declining balance. It's a seven year property. So year one, it's 857, year two, 1469, year three, 525. Therefore, the adjusted basis is the cost minus year one, minus year two, minus year three. The adjusted basis is 3,149. Now we received 4,300 minus the adjusted basis gave us again of 1,151 formakers. So formakers we had a gain. Now we're gonna have to do the same thing for AMT. For AMT, we're gonna use a different schedule. We're gonna use the seven year 150 declining balance. Year one is 643, taken the asset times the rate. Year two, 1791, year three, 451. And here's what's gonna happen. Our basis in this property, our basis in this property is the cost minus year one, year two, year three. The basis is 3758. Now what we do is we'll take consideration received minus the basis under AMT. We'll give us a gain under AMT of 542. So what happened is now makers gain is more than AMT. We have another negative adjustments. That's good for us. We have another negative adjustments. Why? Because we did not take depreciation early on. We took less depreciation. Therefore we have less gain. Therefore we have a negative adjustment. So the difference between the two is a negative adjustment of 609. So let's take a look at the Excel sheet and input that 609 dollars to see how this all fits together. Negative 609. So this is what we did up to this point. So those three adjustments. Now in the next session, I would look at the incentive stock option and preferences. So we need to take a look at more adjustments because those are not the only one. As always I'm gonna remind you to like this lecture. Please don't forget to visit farhatlectures.com, subscribe, share it with others, wait for part two where we're gonna complete this Excel sheet and help you understand how adjustments and preferences fit into this whole picture. Good luck and stay safe.