tax management: taking full advantage of AMT sweet spot

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learning_head
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tax management: taking full advantage of AMT sweet spot

Post by learning_head » Thu Dec 14, 2017 12:55 pm

AMT sweet spot is explained very well at

https://www.kitces.com/blog/evaluating- ... -amt-bite/

In short, this is where your marginal rate within AMT zone drops from 35% down to 28% (due to phase-out ending) and before AMT zone ends which hikes the marginal rate to 39%+.

When I had looked at the graph in that article for a single filer it suggests ~$250,000 of sweet spot range (from ~$336k to ~$588k of income). Unfortunately this does not seem to be generally the case and is highly dependent on particulars whether sweet spot even applies.

Purpose of this post is to share my findings as well as to see if someone finds a flaw in them. The goal is to take maximum advantage of the sweet spot in a given year.

Simplified scenario: single filer able to prepay property taxes to increase Schedule A deductions as needed. Also able to bring in as much ordinary income as needed into the current year from the next. Assume no interest, no dividends, no cap gains/losses, and no other entries. Just an ordinary income and a flat 4% state+local tax on that income.

Here is what I am finding (based on 2016 tax year law) when only changing property tax on Schedule A:

$0k property tax, AMT sweet spot range is 335,298 - 338,186 (i.e. less than 3k range)
$5k property tax, AMT sweet spot range is 335,298 - 366,901 (i.e. $31,603 range)
$10k property tax, AMT sweet spot range is 335,298 - 398,550 (i.e. $63,252 range)

So, it seems like if you want to take advantage of a sweet spot in above scenario, you'd prepay property tax as much as possible and get AMT sweet spot range expanded by much larger amount.

Does this look right? (I did this based on a custom spreadsheet and wanted to see if someone can verify.)

Is there any downsides to this approach?

For example, prepaying State/Local income tax may seem like a similar idea but if you get a refund for the year, you have to then deduct all the benefit you got this year from the next year's taxes. So, I don't believe prepaying state/local taxes really helps here much. However, I don't believe similar considerations apply to prepaying property taxes. Can anyone confirm this?
Last edited by learning_head on Fri Dec 15, 2017 4:20 pm, edited 1 time in total.

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FiveK
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Re: tax management: taking full advantage of ATM sweet spot

Post by FiveK » Fri Dec 15, 2017 1:52 am

learning_head wrote:
Thu Dec 14, 2017 12:55 pm
Does this look right? (I did this based on a custom spreadsheet and wanted to see if someone can verify.)
Looks good, using the tax calculations in the personal finance toolbox spreadsheet for comparison. The current version is for 2017, but the difference between that vs. 2016 for the sweet spot range should be small.

E.g., for the $10K property tax:
Image

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FIREchief
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Re: tax management: taking full advantage of ATM sweet spot

Post by FIREchief » Fri Dec 15, 2017 2:25 am

Is your assumption of "no capital gains or dividends" real, or just intended to simplify the example? Reason I ask is, that if you do have some meaningful capital gains/qualified dividends you'll also want to watch to see if at some point in the pursuit of the AMT sweet spot you're bumping from 15% to 20% capital gains. That can bump somebody working through the AMT range from 35% marginal to 40% marginal for the duration of the qualified gains and dividends.

btw: I'm certain that you mean "AMT" sweet spot, not "ATM" sweet spot. Not sure how an ATM could be a sweet spot, unless it was spitting out cash for free (just joking, the cops would catch you for certain). 8-)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

learning_head
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Re: tax management: taking full advantage of AMT sweet spot

Post by learning_head » Fri Dec 15, 2017 4:20 pm

FIREchief, it was a simplifying assumption indeed. Could you elaborate regarding going from 15% to 20% on capital gains?

Are you saying that if we try to book more capital gains in order to increase income in AMT space, those capital gains would start getting taxed at 20%? In that case I am not worried, since I am trying to only manipulate ordinary income to take advantage of more AMT space, not cap. gains.

On the other hand, if you are saying bumping up ordinary income may lead to some of cap gains to jump from 15% to 20%, please let me how / when that would happen?

(Will change thread title - thanks)

FiveK, thank you for confirmation! (Was that based on 4% state/local taxes?)

Does anyone see any issue with prepaying property tax (so as to increase the number on line 6 of Schedule A)?

I guess this also means, it makes sense to prepay State/Local taxes so as to owe less or nothing. Overpaying these taxes won't make a difference since effects of any refund will be subtracted out next year to the extent that refund benefits taxes this year. However, making sure to pay at least what will be owed next year still makes sense in order to expand the AMT sweep spot.

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FiveK
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Re: tax management: taking full advantage of AMT sweet spot

Post by FiveK » Fri Dec 15, 2017 4:36 pm

learning_head wrote:
Fri Dec 15, 2017 4:20 pm
...if you are saying bumping up ordinary income may lead to some of cap gains to jump from 15% to 20%, please let me how / when that would happen?
Yes, that can happen. See Common examples of high marginal rates for the general logic. Don't recall the specific dollar amount of the 15%/20% change.
FiveK, thank you for confirmation! (Was that based on 4% state/local taxes?)
Yes. You could use the same tool to check what happens if you also have capital gains, etc.

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Artsdoctor
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Re: tax management: taking full advantage of AMT sweet spot

Post by Artsdoctor » Fri Dec 15, 2017 5:36 pm

I would caution you to use a software program and to be flexible. I have had many, many years where things look great (comfortably in the AMT sweet spot) only to have a very small deduction, tax, or unexpected income change things wildly. Perhaps this looks good on paper, but if you have just a few moving pieces change at once, your marginal rate can change in no time.

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FIREchief
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Re: tax management: taking full advantage of AMT sweet spot

Post by FIREchief » Fri Dec 15, 2017 5:48 pm

learning_head wrote:
Fri Dec 15, 2017 4:20 pm
FIREchief, it was a simplifying assumption indeed. Could you elaborate regarding going from 15% to 20% on capital gains?

Are you saying that if we try to book more capital gains in order to increase income in AMT space, those capital gains would start getting taxed at 20%? In that case I am not worried, since I am trying to only manipulate ordinary income to take advantage of more AMT space, not cap. gains.

On the other hand, if you are saying bumping up ordinary income may lead to some of cap gains to jump from 15% to 20%, please let me how / when that would happen?
The later. You may wish to study the Qualified Dividends and Capital Gains worksheet in the 1040 instructions. If you have qualified gains and dividends, this worksheet is what you use to calculate your "regular" taxes due. The AMT form also uses values from this worksheet to complete Part III. Under current law, if your taxable income exceeds the 39.6% bracket thresholds, your gains become taxable at 20% instead of 15% to the extent that your gains increase your income over that threshold (i.e. if you have $10K in gains, and your taxable income is $5K over the threshold, you'll pay 20% capital gains tax on $5K of your gains).

These thresholds are retained separate from the bracket structure in current "discussions", so expect them to remain largely unchanged for future planning regardless of what else could happen. This can become very complicated to wrap your head around. I had to resort to a complex spreadsheet to fully understand how incremental income within the AMT range behaved. Ultimately, I've modeled how both decreasing income through front loading my DAF, and increasing income by executing additional Roth conversions, affects my effective total marginal rate. Once you have all the factors captured, it is easy to see how backing away from the top AMT limit first saves 28% (the sweet spot), then 35% (within the exemption phaseout), then ~40% (exemption phaseout plus reduction of gains taxes from 20% to 15%) and finally back into the 35% (rest of the exemption phaseout). Not sure how other situations may differ, hence my words of caution. Good luck! 8-)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

BigJohn
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Re: tax management: taking full advantage of AMT sweet spot

Post by BigJohn » Fri Dec 15, 2017 6:50 pm

I’ve looked for and found the AMT sweet spot when trying to decide how much Roth conversion to do but.... like our tax code it’s really complex. I tried a few simple estimators and got different answers depending on how much and what simplification was included. Ultimately I had to do a fairly rigorous estimate of income and type, especially LTCG, as well as deductions and type since some have different floors. I put the estimates into 2016 TurboTax and did Roth conversions in increments to generate my marginal and cumulative tax rates.

So I think your strategy is a good one but you may not get the right answer on where the sweet spot starts and ends if your model includes too much simplification.

learning_head
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Re: tax management: taking full advantage of AMT sweet spot

Post by learning_head » Fri Dec 15, 2017 11:54 pm

Thank you, all! Great replies!

Cap gains in situations I consider are not at the level to be affected by 15%-20% change but this is interesting. (The incomes considered in my case are under 39.6% bracket)

After playing some more, I think I understand now why small changes in property tax creates extra sweet spot range of AMT to the tune of 6-7 times that much. I think it's because extra $X property tax on Schedule A results in $X * 33% reduction in regular income tax. So, when you are at the highest point of the sweet spot range (i.e. where AMT tax = regular tax) and you lower your regular tax by $X * 33%, it will take another $Y of additional sweet spot range for regular income to again catch up with AMT. It's catching up at the speed of 5% ( = 33% regular tax rate increase - 28% amt rate increase). So, overall sweet spot range is increased by $X * 33% / 5% =~ $X * 6.6. This is rough in part because as income increases, so do state/local taxes for example. In my examples, 5k increase in property tax increased the AMT sweet spot range by ~30k+.

I appreciate all the thoughtful replies and the links!

Bacchus01
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Re: tax management: taking full advantage of ATM sweet spot

Post by Bacchus01 » Sat Dec 16, 2017 12:05 am

FiveK wrote:
Fri Dec 15, 2017 1:52 am
learning_head wrote:
Thu Dec 14, 2017 12:55 pm
Does this look right? (I did this based on a custom spreadsheet and wanted to see if someone can verify.)
Looks good, using the tax calculations in the personal finance toolbox spreadsheet for comparison. The current version is for 2017, but the difference between that vs. 2016 for the sweet spot range should be small.

E.g., for the $10K property tax:
Image
I can't figure out how to make those charts work in the spreadsheet. I wish there was an easier tutorial. I can change the tax number, but how to get it to graph the X value?

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FiveK
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Re: tax management: taking full advantage of ATM sweet spot

Post by FiveK » Sat Dec 16, 2017 1:01 am

Bacchus01 wrote:
Sat Dec 16, 2017 12:05 am
I can't figure out how to make those charts work in the spreadsheet. I wish there was an easier tutorial. I can change the tax number, but how to get it to graph the X value?
There is some information in rows 18-35 of the 'Instructions' tab, and F106:M114 of the 'Calculations' tab.

It's one of those things that are near impossible when one doesn't know the trick, and very easy after one learns it. ;) In this case, a little familiarity with Excel "data tables" goes a long way.

Regarding a portion of the 'Instructions':
- The Calculations tab must be Unprotected. Use Review>Unprotect Sheet. There is no password.
- After selecting cells P82:R583, click Data>What-If Analysis>Data Table… and enter the cell you wish to vary in "Column input cell:".
A quick way to select cells P82:R583 is
1) left click in cell P82
2) hold down the Shift key and press and release the RightArrow key twice
3) still depressing the Shift key, press and release the End and DownArrow keys in succession
...after which one can rejoin the instructions at "click Data>What-If Analysis>Data Table" etc.

Does that help?

Bacchus01
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Re: tax management: taking full advantage of ATM sweet spot

Post by Bacchus01 » Sun Dec 17, 2017 9:40 pm

FiveK wrote:
Sat Dec 16, 2017 1:01 am
Bacchus01 wrote:
Sat Dec 16, 2017 12:05 am
I can't figure out how to make those charts work in the spreadsheet. I wish there was an easier tutorial. I can change the tax number, but how to get it to graph the X value?
There is some information in rows 18-35 of the 'Instructions' tab, and F106:M114 of the 'Calculations' tab.

It's one of those things that are near impossible when one doesn't know the trick, and very easy after one learns it. ;) In this case, a little familiarity with Excel "data tables" goes a long way.

Regarding a portion of the 'Instructions':
- The Calculations tab must be Unprotected. Use Review>Unprotect Sheet. There is no password.
- After selecting cells P82:R583, click Data>What-If Analysis>Data Table… and enter the cell you wish to vary in "Column input cell:".
A quick way to select cells P82:R583 is
1) left click in cell P82
2) hold down the Shift key and press and release the RightArrow key twice
3) still depressing the Shift key, press and release the End and DownArrow keys in succession
...after which one can rejoin the instructions at "click Data>What-If Analysis>Data Table" etc.

Does that help?
I'm still confused. The information above is straightforward, but I'm still not sure what to put in the What-If Analysis input cell.

Let's use an example. I want to see the impact property taxes on total and marginal tax rates to determine if I pay them this year or next.

Or if I want to see the impact of a 457 plan on total and marginal tax rates to use the property deferred level. How do I change the graph?

The base graph for me, using 401K versus tax rates, shows nothing but a straight line at -35%

bsteiner
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Re: tax management: taking full advantage of AMT sweet spot

Post by bsteiner » Sun Dec 17, 2017 10:21 pm

It's an opportunity to do Roth conversions at 28%.

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FiveK
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Re: tax management: taking full advantage of ATM sweet spot

Post by FiveK » Sun Dec 17, 2017 10:52 pm

Bacchus01 wrote:
Sun Dec 17, 2017 9:40 pm
...I'm still not sure what to put in the What-If Analysis input cell.
The base graph for me, using 401K versus tax rates, shows nothing but a straight line at -35%
Let's use an example. I want to see the impact property taxes on total and marginal tax rates to determine if I pay them this year or next.
Ok, examples are good. E.g., putting 480000 in cell B3, and 2 in both G2 and G3, reproduces what you see. The negative 35% is because that is a 35% saving: tax decreases as the 401k contribution increases. Graphs of tax vs. income will usually show positive marginal rates.
Or if I want to see the impact of a 457 plan on total and marginal tax rates to use the property deferred level. How do I change the graph?
Let's take the easy one first.

To change the x-variable to monthly property tax, one would use B12 as the "Column input cell".
Image

This gives
Image
the same effect as 401k contributions. Does that make sense?

To change the x-variable to monthly property tax, one would use B78 as the "Column input cell".
Image

...and that gives a blank graph. Ok, what's going on? Ah...property tax is not one of the pre-coded x-axis items. Best thing to do - easy for one to say when one doesn't have to do it ;) - might be for the programmer to handle any of the B76:B128 choices automatically. If you have an account on MMM, you could make that suggestion...?

But it appears there is a quick workaround. Make the highlighted change in cells V102:X102,
Image
so the program knows how to handle "B78", and one gets (with cell P82 = 5, for the desired scaling)
Image

That odd-looking (but I think correct) result is due to a few things:
1) Bare bones example used: $480K salary only income; no other itemizable deductions (state income tax, charitable contributions, etc.)
2) Pease limitation on deductions
3) AMT effect

Using your actual numbers will likely provide a different graph, but still subject to Pease and AMT effects - as it should be.

Bacchus01
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Re: tax management: taking full advantage of AMT sweet spot

Post by Bacchus01 » Sun Dec 17, 2017 11:37 pm

Thank you. That's helpful and I'll give it a try and work on it.

I'm curious, how do you create a graph of your marginal rate versus income to see where AMT spots are? Which income spot would you use to compare that to?

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FiveK
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Re: tax management: taking full advantage of AMT sweet spot

Post by FiveK » Mon Dec 18, 2017 12:25 am

Bacchus01 wrote:
Sun Dec 17, 2017 11:37 pm
I'm curious, how do you create a graph of your marginal rate versus income to see where AMT spots are? Which income spot would you use to compare that to?
Yes, constrained nonlinear multi-variable optimization problems are somewhat difficult, aren't they?

For graphical solutions (at least, with a two-dimensional graph as we are using here) one has to fix all but a single variable, then plot the response as that single variable changes. E.g., one might hold everything fixed except something one can choose to change, such as
- tIRA withdrawals
- capital gains
- etc.
and look at marginal rates for each of these.

When it comes varying more than one thing at a time (and certainly if varying more than two things at a time), numerical methods such as the Excel Solver add-in or linear programming techniques such as i-orp uses, become necessary.

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