• $24,900 of the capital gain would be subject to a 0% tax rate.
  • $389,950 of the capital gain would be subject to a 15% tax rate.
  • $3,585,150 of the capital gain would be subject to a 20% tax rate.
  • The total capital gains tax would equal $775,523, for an effective capital gains tax rate of 19.39%.

Alternative Minimum Taxable Income (“AMTI”)
AMTI includes many items of income that are also taxable for ordinary income tax purposes, but probably most important to AMT is that many deductions that are allowed to reduce ordinary taxable income are not allowed to reduce AMTI. Also, some items of income that are tax-free for ordinary income tax purposes are not tax-free for AMT purposes, such as interest income from private activity bonds. This may result in AMTI being higher than ordinary taxable income, which may further result in AMT being more than the ordinary income tax. A taxpayer must pay the higher of the two taxes.

Taxpayers are allowed an exemption from AMT, which, up until recently, was not indexed for inflation. ATRA decreed that the AMT exemption would be indexed annually for inflation. For 2015, the exemption is $83,400 for married couples filing jointly and $53,600 for single taxpayers. However, once a single taxpayer has 2015 AMTI of $119,200 and a married couple who file jointly have 2015 AMTI of $158,900, the AMT exemption starts to phase out.

By a simple scan of IRS Form 6251 (Alternative Minimum Tax -- Individuals), one can see the many items of income and deductions that are treated differently for AMT and ordinary income tax purposes. For example, state income taxes and property taxes are not deductible for AMT purposes. Also, the standard deduction is not allowed for AMT purposes. AMT rates are 26% or 28% of AMTI depending on the taxpayer’s AMTI, although the long-term capital gain tax rate used for ordinary taxes is also used for AMT.

Medicare Net Investment Income Surtax
The surtax is an additional tax on ordinary income and capital gains that meet the definition of net investment income. Net investment income includes interest, dividends, rents, royalties, the taxable amount from an annuity and passive activity income, as well as the gain from the sale of capital assets. Taxpayers who have modified adjusted gross income (“MAGI”) above the thresholds are exposed to the surtax. The threshold for a single taxpayer is $200,000 and for married couples filing jointly is $250,000 (these thresholds are not indexed for inflation). For purposes of the surtax, MAGI is defined as adjusted gross income (“AGI”) plus foreign earned income that was excluded from AGI.

The formula to calculate the surtax for individuals is:

3.8% × the lesser of: (1) net investment income or (2) MAGI -- threshold

Sample Client
Let’s review various income tax situations for a married couple when they change their investments.

Example 1: Married couple filing jointly who have the following income in 2015:

  • Wages = $650,000
  • Taxable Interest = $75,000
  • Qualified Dividends = $125,000
  • Net Long-Term Capital Gain = $150,000

Ignoring any itemized deductions, standard deductions or personal exemptions, the couple has taxable income of $1,000,000, of which $275,000 is subject to long-term capital gains tax rates. This would result in:

  • Ordinary Income Taxes = $233,016 (no AMT in Example 1)
  • Capital Gain Taxes = $55,000
  • Net Investment Income Tax = $13,300
  • Total 2015 Income Taxes Payable = $301,316

Example 2: If the couple invested in municipal bonds that produced $300,000 of tax-free interest income instead of other investments that produced the taxable interest, qualified dividends and capital gains, the couple would have ordinary taxable income of $650,000 (wages); however, the $300,000 of interest from the municipal bonds is subject to AMT (assuming they are private activity bonds), resulting in: