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How AMT can make prepaying state and local taxes a false move. Prepaying state and local taxes is a venerable year-end tax planning move. It can also be a costly one, thanks to the Alternative Minimum Tax. If you are in AMT this year — perhaps thanks to a big non-recurring capital gain — but you won’t be next year, prepaying your state and local taxes might result in your taxes actually being much higher over the two-year period.
An example involving a fictional Iowa married couple shows how this works. The couple has one earner with $150,000 in self-employment earnings in 2014 and 2015. In 2014 the couple generates $300,000 in a one-time capital gain.
If the couple prepays their 2014 state tax on the capital gain, they get a federal tax benefit of precisely zero in 2014; the capital gain causes them to be in AMT whatever they do because the capital gain rates are the same for AMT and regular tax.
In 2015, the couple has no AMT on their $150,000 of self-employment income. Nor do they have AMT even after paying both their 2014 Iowa balance due and their 2015 Iowa estimates. My projection software comes up with these numbers (yes, oversimplified, but the concepts hold):
This shows that prepaying the taxes would be a $6,043 mistake for the couple.
There are cases where prepaying state taxes makes sense. There are also cases where AMT makes doing so a blunder. Make sure you run the numbers before you mail that check.
In case you missed it over the holidays, central Iowa’s only SHOP marketplace insurance provider was taken over by Iowa’s insurance regulators last week. Read about it here.
William Perez offers A First Look at ABLE Savings Accounts. These accounts, included in this month’s “extender” bill, allow Section 529-like benefits for accounts set up to pay disability costs.
Robert D. Flach, THE CLOCK IS TICKING. For 2014 Qualified Charitable Distributions from IRAs.
Mitch Maahs, Summary of the Tax Extenders in the Tax Increase Prevention Act (Davis Brown Tax Law Blog)
Jack Townsend, Tax Return Preparers Convicted of Conspiracy and Failure to File FBARs. They chose badly.
Cara Griffith, Crowdfunding and State Taxation (Tax Analysts Blog). Is Kickstarter funding taxable income or taxable sales?
Peter Reilly, Phantom Mares And Real Trucks Don’t Make For A Winning Horse Loss Tax Case. Plus, it’s really hard to find good phantom breeding studs.
Renu Zaretsky, Will Tax Reforming Be Forgot and Never Brought to Mind? This TaxVox headline roundup covers the Kansas struggles with careless tax reform, among other things.
TaxProf, The IRS Scandal, Day 599
To punctuate his point, he grabbed a pen and a cloth cocktail napkin and drew a chart showing that when tax rates get too high, they penalize work and investment and can actually lead to revenue losses for the government. Four years later, that napkin became immortalized as “the Laffer Curve”…
The idea that tax rates can become so high that they actually reduce net revenue shouldn’t be controversial. If you have a 100% tax rate on an activity, you will avoid that activity, or at least letting the government know about it. Of course, a zero rate will also generate no tax revenue. The revenue-maximizing rate is somewhere in between.
Unfortunately, some people on the right have taken this point and jumped to the conclusion that tax cuts will always cause such increased taxable activity that tax revenues will increase. That’s as much a fallacy as left-side assumptions that increasing taxes can never be economically-harmful or revenue-reducing.
The real issues should be identifying the point at which the harms to economic activity and to revenues occur. It seems likely that the economically-damaging rate is lower than the revenue-maximizing rate, as Megan McArdle discusses here. These points have to differ for different kinds of tax. A 30% income tax rate might not be very destructive to economic activity, but a 30% sales tax would hurt, and a 30% gross receipts tax would be ruinous. The results also differ for state and federal taxes, given how much easier it is for activity to to move between states than between countries.
All this, of course, ignores the obvious question of how much revenue the government needs in the first place. I would argue that a well-run government limited to its proper sphere wouldn’t have to ask these questions all the time.