By Darlene Pulliam Smith
Audit Guide Emphasizes Separate Recordkeeping
Numerous taxpayers are feeling the bite of the alternative minimum tax (AMT) as a direct result of the proliferation of tax preference items. To clarify application of the AMT for individual taxpayers, the IRS has issued a new audit guide in its Market Segment Specialization Program (MSSP). The author identifies situations most likely to be encountered and explains the examples given by the audit guide. In addition, the author presents a comprehensive list of audit techniques for AMT items.
It is no surprise to tax practitioners that the alternative minimum tax (AMT) requires a massive amount of recordkeeping. An audit guide recently issued by the IRS, Market Segment Specialization Program: Alternative Minimum Tax for Individuals, confirms the need for a second set of extensive schedules for AMT adjustments.
The Audit Guide
The audit guide consists of five chapters. Chapter 2, which specifically addresses adjustments and tax preferences, concludes each item with a discussion of audit techniques (the Table analyzes these techniques). Practitioners should prepare for a potential audit by reviewing the techniques and generating proper documentation during tax return preparation.
Most of the adjustments and tax preferences require only a simple positive adjustment or a computation for the current year. For example, for regular tax purposes, medical expenses can be deducted to the extent that the total expenses exceed 7.5% of adjusted gross income (AGI). For AMT purposes, medical expenses can only be deducted to the extent that total expenses exceed 10% of AGI. The positive adjustment is a simple computation.
Other adjustments, however, are timing differences requiring multiple-year schedules. Pointing to several adjustments that require such complicated schedules, the audit guide advises that auditors request detailed schedules for both regular tax and AMT for—
The last three items pertain to specialized industries, but the others may apply to many taxpayers. Multiple-year schedules are also required for taxpayers with net operating losses (NOL) and AMT credits.
Of the items requiring extensive schedules to arrive at both regular tax and AMT deductions, the AMT adjustment for depreciation deductions (and the related basis adjustment for gain or loss upon a sale) is by far the most common.
Example 9 in the MSSP audit guide, a simple example for only one asset, illustrates the information an auditor might request. Samantha is an independent court reporter. On June 6, 1994, she purchases and places into service a new word processor that costs $6,500. For regular tax purposes, depreciation was computed on a 200% declining balance, five-year property basis, as follows:
For AMT purposes, depreciation was computed as follows:
The difference between regular and AMT depreciation will require a positive or negative adjustment each year as follows:
Example 10 in the audit guide is a simple illustration of the adjustment upon sale of assets. Given the previous example, assume that Samantha sold the word processor during the third year of use for $5,950:
Gain for Regular Tax Purposes
|Less adjusted basis|
|Gain on Sale||$3,454|
Gain for AMT Purposes
|Less adjusted basis|
|Gain on Sale||$2,663|
In this example, there is a negative adjustment to AGI of $791.
The passive activity loss limitation must be computed using the regular tax provisions and, separately, using the AMT provisions. The loss limitation is applied separately to each, with the differences between them resulting in an adjustment.
Example 13 in the audit guide illustrates the information the auditor would request. Don actively participates in a rental real estate activity with the following income and expenses:
Regular Tax AMT Income $50,000 $50,000 Real estate taxes ($9,000) ($9,000) Wages ($11,000) ($11,000) Operating expenses ($25,000) ($25,000) Depreciation (27.5 years) Basis = $400,000 ($14,544) Depreciation (40 years) – ($10,000) Total losses ($9,544) ($5,000)
The adjustment required to be shown on line 11 of Form 6251 will be the difference between the two amounts shown above, an add back of $4,544. This depreciation adjustment must be made as a passive loss adjustment on line 11 and should not be included on line 8-adjustment depreciation, which is the case for all IRC section 56 and 57 adjustments required for passive activity losses.
If this activity were not rental real estate, each of these losses would be suspended. A schedule would be required to determine when there was passive income to allow for the losses to be deducted, for both regular tax purposes and AMT purposes and to determine the amount of losses not used and still suspended.
Losses for home offices, at-risk property, and basis activities must be accounted for separately under the regular tax and the AMT.
Example 20 in the audit guide illustrates the information the auditor would request for these loss limitations. Chris is at risk for a property in the amount of $100,000 in 1993. For regular tax purposes, the property has a loss of $125,000. The loss will be limited to the amount at risk of $100,000. After considering all AMT adjustments and preferences, the property has an AMT loss of $90,000, all of which will be deductible in 1993. If in 1994 Chris has a regular loss of $30,000 and an AMT loss of $15,000, he will be allowed no loss for regular purposes and a $10,000 loss for AMT purposes. The 1993 return will show a positive adjustment of $10,000, and the 1994 return will show a negative adjustment or additional loss of $10,000. The suspended loss for regular tax purposes will be $55,000 ($25,000 for 1993 plus $30,000 for 1994) and for AMT purposes will be $5,000 (no suspended loss in 1993, $5,000 in 1994).
Schedules will be required for both regular tax and AMT to account for the amounts suspended in some years and used in others.
Net Operating Losses
The computation of NOL for regular tax purposes is quite complicated. An individual’s current NOL is determined by starting with regular taxable income and making a series of adjustments. The recomputation of taxable income and the tax refund for a carryover year are equally complicated. These same schedules must be completed for AMT, considering AMT adjustments and preferences. The AMT schedules are further complicated by the 90% of AMT income limitation and the independent carryovers that sometimes occur due to the differences in the regular tax NOL and the AMT NOL.
Example 27 in the audit guide contains a simplified illustration of the reconciliation of a regular tax NOL and an AMT NOL. Gary has $700,000 of gross income and $1 million in deductions for 1993. The deductions include $100,000 of depreciation. Depreciation for AMT purposes is $60,000, resulting in an AMT adjustment of $40,000. Gary’s AMT NOL is computed as follows:
Gross Income $700,000 Less: Deductions ($1,000,000) Regular Tax NOL ($300,000) Plus: AMT depreciation Adjustment $40,000 AMT NOL ($260,000)
Documentation Is Crucial
Examination of the audit guide and the audit techniques will assist practitioners in developing proper documentation as tax returns are prepared. Further information can be obtained from the audit guide, at www.irs.gov by searching for MSSP.
©2009 The New York State Society of CPAs. Legal Notices
Visit the new cpajournal.com.