Jimmy J. Williams, CPA/PFS, CFP®
Another Type of Income Tax
As we get closer to Thanksgiving Day, it jars in my mind the opportunities we have to reduce our taxable income. The important matter to remember is that most humans, in the United States, are calendar-year, cash-basis taxpayers. There are many more tax planning strategies available to us prior to the close of the year than after a new year begins. The thought of deferring income and accelerating deductions may be a good method of tax planning unless you are subject to the Alternative Minimum Tax (AMT).
This secondary system of taxing individuals and corporations arose from a period in time that very wealthy individuals and large corporations could control their tax liabilities by purchasing certain types of investments and spending cash on particular deductions. Taxpayers with significant assets and cash flow can purchase municipal bonds, for example, that pays tax-exempt interest to them. Some municipal bonds are exempt from federal, state and alternative minimum tax! As you can imagine, if you were ultra-rich, you would want to remain as wealthy as possible by avoiding the highest income tax marginal rate of 37% (unless additional surtaxes apply based on your type of income).
Just when you thought you were done with your tax return calculation of liability, your CPA calculates the Alternative Minimum Tax. You originally thought your income would be taxed at the individual rate of 15%. However, based on the amount of interest you earned from private activity bonds, percentage depletion on royalty income from your investments in gas and oil properties as well as accelerated depreciation on your business property, your Alternative Minimum Taxable Income (AMTI) is now above the AMTI exemption exposing your income to a 26% tax rate.
Why did Congress do this to the American people? The purpose and history of the Alternative Minimum Tax was to insure certain higher-income taxpayers paid taxes. Our tax system is one based on income attributed to the taxpayer and certain types of income may be tax-free, tax-deferred or partially-taxed. However, the AMT Exemption amount for 2023 is $126,500 for married filing jointly and surviving spouses and $81,300 for single individuals and heads of households which is more than the national average per worker in the United States.
Bracket “creep” has been a considerable challenge for middle class taxpayers in recent years. Congress has not routinely addressed the exemption amounts for inflation. When this occurs, there is little difference between the tax exemption and the Alternative Minimum Tax Exemption which causes those that can afford it least to pay the higher 26% tax rate.
While planning for your 2022 income tax liabilities, it is critical that you understand the complexities of the Internal Revenue Code. Preparing your income tax returns yourself may save you a few hundred dollars today and cost you much more if the IRS adjusts your returns for errors.
I live with a variety of philosophies in life. One of those philosophies is that it is not unpatriotic to pay the least amount of income tax one rightfully and lawfully owes. Planning is an activity that gives you more control in how much tax you wish to pay each year. It is critical that you understand the different types of income and the rates applied to the income during the tax year. “A penny saved is a penny earned,” according to poet George Herbert. If you had a choice to invest your heard-earned money in something that returns interest or dividends directly to you rather than paying the U.S. Government, wouldn’t you do so? Contact a CERTIFIED FINANCIAL PLANNER™ professional to help you plan to lower your taxes for 2022 and beyond. Wishing you and your family the most blessed of Thanksgivings!
Registered Principal, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Jimmy J. Williams is an Investment Advisor Representative of Compass Capital Management, LLC, a Registered Investment Advisor. Cambridge and Compass Capital Management, LLC are not affiliated. 321 S. 3rd, Ste. 4, McAlester, OK 74501.