 Hello and welcome to this session. This is Professor Farhad in which we would look at the alternative minimum tax part two of five. Part two means I already completed part one and in part one we looked at the introduction of AMT and we looked at certain adjustments. In this session we're going to look at additional adjustments and cover the preferences. This topic is dreaded by many students and it's covered on the CPA exam as well as an income tax course. 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 one thousand seven hundred plus accounting, auditing, tax, finance as well as Excel tutorial. If you like my lectures please like them, share them, put them in playlists. If they benefit you it means they might benefit other people. Share the wealth and connect with me on Instagram. On my website farhadlectures.com you will find additional resources to supplement your education. The way I teach the material is totally different than a CPA firm. So if you're looking for in-depth explanation about taxes, audit, finance, accounting check out my website farhadlectures.com. So let's review real quick what we learned in the prior session for the AMT. We'll start with regular income tax. We add to it the standard deduction. If the standard deduction is taking then we have adjustments and preferences, adjustments and look at certain adjustments. Then we add the preferences. Today we're going to cover up to this point. So today by the end of the session we're going to come up to alternative minimum taxable income before exemptions. Then we'll have a whole session about exemption. Then we'll deduct our exemption that's given by the government subject to inflation every year. Then we come up with alternative minimum taxable income base. We multiply that base by either 26 or 28 minus 37 26 and you will see why. Then we will come up to to our tentative AMT before credit. If we have any credits, we don't have much but if we have foreign credit, we'll deduct foreign credits and we come up with our tax AMT tax. Now we compare our AMT tax to our regular tax. If AMT tax is greater than regular tax, we pay the difference. So if the AMT tax is 65,000, our regular tax is 60,000. We have to pay the balance of 5,000 and this 5,000 will be considered the AMT and this will be added in addition to our tax. And this is what we did in the prior session. We started with a fictitious example with the regular taxable income of 154,650. We added the taxes that was deducted on schedule A. We added the difference in depreciation on the rental property. We subtracted the negative adjustments for the depreciation too because we had a positive adjustment and negative adjustment and we had the negative adjustment for the sale of the asset. Now we're going to look at incentive stock option and other adjustments and preferences. So basically, we're going to come up with this number at the end of this session. This is what we're looking to achieve. So other AMT adjustments, one is incentive stock options, long-term contract, circulation expenditure, but those are not the only one. There are many others, but those are the one. If you understand them, you'll be good for the CPA exam. And if you understand how to deal with those adjustments, you can deal with any other adjustments down the road. So understanding is the key. Okay? So let's take a look at the first one. Incentive stock options. First of all, what are stock options? Stock options is when the company want to motivate employees, want to compensate employee, they want to retain them. So what they do is let's assume you work for Apple computers and Apple computers right now is trading at $350 per share. You work for Apple and what they do is they will give you 1000 options to buy the shares at 400. Well, guess what? Those 1000 options are worthless to you. Why? Because you can buy the share today for 350. But what they would do, they will give you five years. So in the next five years. So the options are available for you in the next five years. Well, that's different. If that's the case, then between now and year five, five years from now, Apple share will hopefully go above 400 and every dollar above 400 equal to 1000 profit in my pocket because now I can only, I can buy it at 400. So this is what stock option is to align, is to make the employee feel that they are part of the company, they're part of the equity structure of the company. So for regular tax purposes, when we talk about regular tax purposes, when we exercise those options, we have no income. So for regular tax, we have no income. So for AMT purposes, there is a positive adjustment and that positive adjustment will equal to the fair market value of the stock, less the amount the taxpayer paid, including any amount paid for the option. How does it work? Let's take a look at it. Adam works for a large publicly traded company and receives incentive stock option as bonuses. Adam exercises options to purchase 10,000 shares at $13 per share when the fair market value is 18. So Adam had 10,000 shares available to him and he can buy each share at 13, but the price today for the stock is 18. So immediately, if Adam wants to, can turn around and sell his shares for 18. And as a result, he's buying 1000 shares, I'm sorry, 10,000 shares, not 1000, he's buying 10,000 shares and he's making $5 profit for each share so he can immediately make 50,000 if he decides to sell them immediately. Now here's what happened from an AMT perspective. From the AMT perspective, they don't care whether Adam sells them or not. All what AMT thinks, well, you bought them at 130, you can sell them at 180, therefore you have an AMT adjustment, you have a taxable profit, although you did not really sell anything. If anything, you purchased the shares. So you purchased the share at 13, but since the fair market value is higher on that date, they assume you have a positive adjustment. Now the funny story about this, and this is a real story, not real story, I lived through this because my first job out of college in 99, 2000, 2001, I work with Merrill Lynch. It's a stock brokerage company. And as a result, what happened is we dealt, I worked with their stock option department. And many companies at that point, I served many companies like Intel, Tyco, PepsiCo, those are the ones that I remember, and especially Intel. Many executives, what they did, they exercised their option, something like this. So the price was, they bought it at 13, it was at 18, they paid the taxes, then they waited, they did not sell the stock for a while, then the stock eventually dropped below 13. So it's like they paid the taxes upfront. They paid the government upfront, but that's a different story. Now what happened is what's your basis for the taxes? Now you're going to have two basis. For regular tax, you have a basis of 130. So when you sell them, you're going to have a more gain. You're going to have more gain. For AMT down the road, when you sell them for AMT, your basis is 180, you're going to have less gains because you already paid taxes on 50,000. Therefore, your basis are higher. You want your basis to be higher. So this is the incentive stock option. And simply put, what we do here, we're going to come up here to this Excel sheet and add $50,000 incentive stock option edition. Let's take a look at other adjustments. And specifically, let's take a look at a revenue adjustment from long-term contract. And this is important to understand. If you had to understand the AMT for corporation, the good news is AMT for corp is repealed. We no longer have to do that. So for AMT purposes, so for AMT purposes, a taxpayer must use a percentage of completion method rather than the completed contract method. So percentage of completion versus completed contract to report income from long-term contract. Now, if you don't know what the percentage of completion method or the completed contract, this is not the time for me to explain it. You can go to my intermediate accounting course and learn the difference between percentage of completion and completed contract. It will take me two to three hours to explain it in details with examples. But as long as you have a good idea today, you'll be able to follow what I'm trying to do. So the adjustment is the difference between the income under the percentage of completion method and the income determined for regular tax purposes. Simply put, we'll compute the income based on the percentage of completion. We compare that income to the completed contract method and we'll find the difference. So in some years, you're going to have positive adjustments. In other years, you're going to have negative adjustment. So in the year in question, if AMT income is smaller, the adjustment is negative. And you like negative adjustment. Negative adjustment means you have less AMT. And the best ways to illustrate this is to look at an example. So the negative adjustment is likely to occur when the contract is completed. Why? Because when the contract is completed, you pay your taxes for regular, then you take it out of the AMT. Let's take a look at an example. Let's assume you sign a project and the project is for four years and the contract is $100,000. The whole price is $100,000. For AMT, and let's assume for simplicity too for the purpose of this example, let's assume it's going to be, you're going to complete your work 25% every year. So for AMT, you would recognize 25,000 year one, 2017, 25,000 year two, 25,000 year three, 25,000 year four. As a result, you would report $100,000 of income over a period of five years. Now, under the completed contract method, what's going to happen in year one, you don't report anything because you have not completed the project. So notice what happened. In 2017, you're going to have a positive adjustment of 25,000. In other words, you're going to add 25,000 to your taxable income from that project. In year two, you're going to add another $25,000 to your taxable income because you don't report anything for regular, but you report 25 for AMT. Year three, the same thing. Now, in year four, you're going to report the whole thing for regular. For regular tax, you're going to report the whole thing. So in year four, what's going to happen, you will deduct out of your, notice here, it's a deduction of 75,000 out of AMT. So let's see when everything all said and done. For AMT, over four years, you reported 100,000. For regular tax, you reported 100,000. Except that AMT, the government wants their money a little bit earlier, a little bit earlier, a little bit earlier. Now, and notice here, plus 25, plus 25, plus 25 minus 75, the amount is zero. So this is an example of a revenue adjustment. Let's take a look at an example at an expenditure, which is an expense adjustment. An example is circulation expenditure, which is expenditure to establish, maintain, or increase the circulation of newspaper, magazine, or other periodical. What you have to do, you have to amortize those over three years. For regular tax, you expense them in the year they are incurred. So let's take a look at an example at a circulation expenditure to illustrate AMT for tax purposes. So let's assume you had $90,000 circulation expenditure. For regular tax, you would expense it the whole amount in the year in question. And that's what you want. You want to get as much deduction as possible. For AMT, what you have to do, you have to split it over one, two, three years. In total, for both regular and AMT, you deducted $90,000. So in year one, you'll have a negative adjustment of $60,000 because you took too much deduction, I'm sorry, you'll have a negative deduction, that's right, negative AMT adjustment. Then in year two and three, you'll have a positive adjustment. You'll have a positive adjustment. So it's very important to understand how expenses and revenue adjustment work. Now, anything that they can throw at you, you should be able to follow. Let's take a look at preferences. Preferences are always added to AMT, so there's any preferences. And what are preferences? Preferences is something that they give you as a bonus. So for regular tax, they give you some preference. So preferences tend to arise because of a deduction or exclusion that provides substantial tax benefit. Guess what? When it comes to AMT, they're going to take away that preference because they think you make too much money. Therefore, they take it away. So unlike adjustments, preferences are always, they'll always increase AMT. So preferences reduce the benefit initially received from computer and regular tax. Examples will be private activity bond. Now, you have to understand we have many bonds and we have private activity bonds. What are private activity bonds? It's when the municipality sponsored a company to issue those private activity bonds. So what happened, the person that buy the bonds, they're treated as money bond for tax purposes. But since they are not from the municipality or from the state, their private activity bond, it's issued by a company but sponsored by the government, then that feature is taken away. Also, they will take away the percentage depletion deduction that's an access over the adjusted basis. For the depletion, you can take more deduction for regular tax purposes in addition to the adjusted basis. For AMT, they will take away the access of the adjusted basis. And the third one is accelerated, pre-1987 accelerated. That's not relevant anymore because those assets are fully depreciated at this point. So simply put, after all said and done, this is what we did up to this point. So in this session, we looked at the preferences. We did not have any preference numbers. We had another adjustments of $50,000 and when we net all those out, we come up with $270,000 and $248,000. And this is formed $6251,000. Notice here, a regular taxable income, $10,000 addition, the $50,000, and this is the net depreciation, $3240,000 and this is the adjustment for the sale of the asset. So basically this is the tax form and this is the, there's a couple of dollar difference, that's fine, rounding throughout the software. The next, what I'm going to do in the next session is I'm going to look at the exemption, basically finish this, finish the form, basically finish the form to show you how the exemption works. So in the next session, what we do is in this session, we went up to here, up to the exemption. In the next session, we would look at the remainder. So next time we'll look at part three of five. As always, please, like the lecture, share it. Don't hesitate to visit my website. You are invested in your career, you're invested in your education. Don't shortchange yourself. I can help you pass. I can help you succeed on the CPA exam. Good luck, study hard and stay safe.