The Surprise Tax - AMT

by Julie Welch and John Meara


The Alternative Minimum Tax (AMT) is currently the most serious problem encountered by taxpayers according to the IRS's National Taxpayer Advocate, Nina Olson in her annual report to Congress. In fact, Ms. Olson herself was surprised when her 2002 tax return included an extra $721 of AMT. Additionally, IRS Commissioner Mark Everson announced this year he too was forced to pay the dreaded AMT.

The AMT is an alternative to the regular tax. After calculating your tax under the regular tax rules, you must then calculate your tax under the AMT rules. The purpose of the AMT is to ensure that people with large amounts of income and deductions pay at least a minimum amount of tax. The tax was originally enacted 35 years ago when Congress learned that 155 taxpayers with adjusted gross incomes over $200,000 (over $1,000,000 in today's dollars) paid no federal income tax. Since 2001, the number of people hit by the AMT has more than doubled from 1.1 mil. to 2.4 mil.

The AMT is calculated in the same fashion as your regular taxable income, but without many regular tax deductions and exemptions. Notably absent are deductions for:

In addition, AMT taxpayers must add back other items, such as tax-exempt interest income from certain bonds and certain gains from exercising incentive stock options. Using the AMT rates, you recompute your tax. If the recomputed tax is greater than your regular tax, the higher AMT becomes your actual tax. Because the AMT adds back deductions allowed in the regular tax calculation, the AMT is often called the "tax on loopholes." Many now question whether the excluded deductions and exemptions should be considered "loopholes."

 

Married filing jointly

$58,000

 

Single or a head of household

$40,250
 

Married filing separately

$29,000


The AMT replaces the eliminated "tax loophole" deductions and exemptions with an AMT exemption, as follows: The AMT exemption phases out by 25¢ for every $1 that your AMT income exceeds the following:

 

Married filing jointly

$150,000
 

Single or a head of household

$112,500
 

Married filing separately

$75,000

 

After determining the alternative taxable income, taxpayers must compute AMT by applying the AMT tax rates. For 2004, the AMT rate is 26% on AMT income up to $175,000 ($87,500 if you are married filing separately) and 28% on AMT income over that amount. When originally enacted into law in 1969, the AMT rate was 20% and the maximum regular tax rate was 77% (a 57% span). Because the current 26% AMT rate is close to the 25% regular tax rate that applies to many people and the 35% highest regular rate, the AMT applies to many taxpayers. Planning for the AMT

If it appears the AMT will apply to you, you should change your tax planning strategies. First, instead of accelerating deductions into the current year, you should defer them to a later year. Your goal is to raise your regular tax to the point that it equals your AMT. For example, since your state and local taxes are not deductible for the AMT, you should wait until January to pay your fourth quarter estimate. In this way, you increase your regular tax and decrease the likelihood that the AMT will apply.

Second, if the AMT applies to you this year but will not apply to you next year, increase your income this year. The AMT rate is 26% or 28%, while your regular tax rate may be higher. Third, the law lets you make certain elections to avoid the AMT. For example, to eliminate the adjustment for accelerated depreciation, you can elect to depreciate your business equipment under a different method. These alternative methods allow the same amount of depreciation but at a slower rate. Thus, you have a higher regular tax and a smaller AMT add back. If you expect to be subject to the AMT for several consecutive years, these elections can help you reduce your tax. Fourth, when you are subject to the AMT, be sure to take the alternative minimum tax credit the next year. If you pay the AMT, you may be eligible for a credit. The AMT you pay does not always produce a credit, however deferral items such as depreciation and incentive stock option adjustments many times will produce a credit. This credit reduces your regular tax in future years. You can use the credit to the extent your regular tax exceeds your AMT for that year. Next year the AMT is projected to hit 65% of married couples with two or more children reporting adjusted gross income between $75,000 and $100,000. In 2010, the AMT is currently projected to affect almost 32 million people, the majority having income under $100,000. If the AMT is not reformed by 2008, the Taxpayer Advocate's report estimates it would cost less to repeal the entire regular income tax structure and keep the AMT than to abolish the AMT. The AMT no longer targets just wealthy taxpayers. Recent tax cuts in the regular rates have caused the AMT to sneak up on millions of unsuspecting taxpayers . . . and you could be one of them. As with any complicated tax situation, be sure to consult your tax adviser.

Julie Welch (Runtz) & John Meara are partners in Meara, King & Co. and con be reached at julie@meara.com or John @meara.com