Capital Gains and the Alternative Minimum Tax

Abstract

The author explores the interrelationship among long-term capital gains, state income tax rates, and the likelihood that the alternative minimum tax will apply. Given a large proportion of long-term capital gains, an individual investor will find himself subjected to the federal alternative minimum tax, despite the fact that long- term capital gains receive favorable tax treatment for purposes of that tax. This conclusion is particularly applicable if the investor resides in a state which has a high state income tax rate. By considering only those variables that are directly related to taxable income, a formula can be developed which determines the proportion of long-term capital gains at which the alternative minimum tax will apply, and calculates that proportion as a function of state income tax rates. This formula provides investors with a means of determining, in a timely manner, whether they will be subject to the alternative minimum tax, so that appropriate timing and planning of taxable transactions can be performed. The author concludes by suggesting several planning alternatives to mitigate this problem, which will only become more significant in future years as federal individual tax rates decline while the alternative minimum tax rate remains unchanged.