Understanding Personal Exemptions

Many people are aware that tax exemptions exist but, unfortunately, don’t really know how to take advantage of them fully or even which ones apply to them.   

This is truly disappointing since knowing which exemptions to file and then filing them can greatly reduce a person’s taxable income, thereby reducing his or her income taxes.

Exemption Examples

There are all kinds of personal exemptions available…many of which are widely underused by the average tax filer.

For example, you can qualify for an exemption if you have at least one person whom you can claim  as a dependent.

Similarly, you can claim two personal exemptions if you are a married person filing jointly, plus exemptions for each of your dependents.

And, even when spouses file their taxes separately, one can often claim the other so long as circumstances allow.

Of course, personal exemption amounts vary based on a variety of factors, but, right now, the current personal exemption allowance is a whopping $4,050, which could be helpful for a lot of people.

Filing Personal Exemptions

Given the vast amount of people who don’t take advantage of the personal exemptions for which they are eligible, you might think that filing for such exemptions is incredibly difficult. In truth, though, it’s really not. It’s just that many people are not aware of their exemption options and/or how to get them.

Typically, you’ll want to use Line 6 of Form 1040 to claim personal exemptions for yourself, your spouse, or for dependents. You’ll also need to include your deductible amount on Form 1040 Line 42 or Form 1040A Line 26. Or, if you’re simply filing Form 1040EZ, you’ll only need to record your exemptions on Line 5.

If that is confusing to you, as it is to many people, don’t just give up and lose out on these exemptions.

Instead, seek the help and advice of a qualified, professional accountant who can make sure that you take full advantage of all of the personal exemptions available to you and that you do so in the best and most beneficial possible way.

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About the Alternative Minimum Tax

The alternative minimum tax was originally enacted to ensure that high-income taxpayers pay at least a minimum amount of tax if they benefit from certain deductions and other tax preference items.

The AMT tax computation is a parallel system to the regular tax system with its own definitions of income and expenses, rules for income recognition and timing, and exemptions and tax rates. Although every taxpayer is subject to AMT rules, the additional tax is paid only if the tax computation under AMT rules is higher than the tax computed under regular rules.

Even though the AMT was originally targeted toward high-income taxpayers, factors, including inflation and treatment of certain tax credits, can sometimes push lower-income taxpayers into an AMT situation.

How AMT Works

Certain items called “adjustments and preferences” are added to federal gross income. Personal exemptions that reduce taxable income for regular tax purposes are not allowed for AMT purposes and are added back to taxable income. A separate AMT exemption amount is allowed, depending on the taxpayer’s filing status. After the AMT adjustments and preferences are added to income, and the AMT exemption amount is subtracted, an AMT tax rate of 26% to 28% is applied. If the resulting tax is greater than regular tax, the difference is added to regular tax on line 45, Form 1040.

Example #1: When computed under regular rules, John’s income tax is $4,700. When computed under AMT rules, the tax amount is $3,900. Since his tax computed under AMT rules is less than his tax computed under regular rules, John will not pay any additional amount for AMT.

Example #2: Assume the same facts as Example #1, except when computed under AMT rules, John’s tax amount is $5,100. Since his tax computed under AMT rules is higher than his tax computed under regular rules, John must pay the difference in additional tax. John must report additional AMT tax on line 45, Form 1040, in the amount of $400.

AMT Triggers

Items that commonly trigger AMT include high deductions for state income tax, dependent exemptions, exercise of incentive stock options, and large miscellaneous itemized deductions reported on Schedule A, Form 1040. Other AMT adjustments and preferences include:

•    Medical and dental expenses. A portion of these deductions may need to be added back for AMT purposes.

•    Taxes from Schedule A, Form 1040.

•    Certain mortgage interest deductions.

•    Tax refunds reported on Form 1040.

•    Certain investment interest expense.

•    Certain depletion expense.

•    Net operating losses.

•    Interest from specified private activity bonds.

•    A portion of gain from section 1202 small business stock.

•    Certain gains from dispositions of property.

•    Certain depreciation adjustments.

•    AMT loss limitations.

•    Certain circulation costs.

•    Long-term contracts.

•    Certain mining costs. 

•    Certain research and experimental costs.

•    Pre-1987 installment sale income.

•    Intangible drilling cost preferences.

AMT “Patch”

Because the original AMT law did not include a provision to index the exemption amount for inflation, over the years, a growing number of middle-income taxpayers have become subject to AMT. Historically, Congress limited the impact of the AMT by passing temporary legislation, often referred to as “patches,” to provide relief for millions of middle-income taxpayers who might otherwise be affected by AMT. Congress has patched the AMT every year for the past several years.

The “fiscal cliff” tax law that was passed on January 2, 2013, included a provision making the AMT patch permanent. Exemption amounts were retroactively increased for 2012 and will be indexed for inflation in future years. Under the new legislation, personal credits will also be allowed against the AMT on a permanent basis.

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