Watch Out for the AMT! by Melinda Bucknam

AMT (Alternative Minimum Tax) is a term that residents of New York will become very familiar with over the next several years.  It was created back in 1969 to prevent the wealthiest Americans from taking excessive advantage of tax laws.  It is an extra tax that some people have to pay on top of regular income tax.  Although it is true that AMT historically applied only to a small minority of high-income households, tax cuts in recent years are projected to lead to an increase in the number of AMT taxpayers from two million in 2002, to 36 million (about 1 out of three taxpayers) over the next several years.   Since AMT adversely affects people who live in heavily taxed states, New York and California are expected to be hit the worst.  In addition, the more children in a family, the more likely it is that AMT will have to be paid.  So, a tax that was originally designed to reduce tax loopholes for the rich has turned into a tax that affects middle income families in heavily taxed states.

Technically, AMT is the excess amount of “tentative minimum tax” over regular income tax.  Taxpayers have to calculate their tax liability under regular income tax rules and then separately under AMT rules to determine their tentative minimum tax.  If their tentative minimum tax is higher than their regular tax, the difference is called AMT and is owed by the taxpayer.   Under the AMT calculation, taxable income will almost always be higher than regular taxable income, because AMT taxable income excludes many deductions and credits available under regular income tax rules.  Given this, you might think that everyone would be subject to AMT, but AMT rules also apply lower rates to your AMT taxable income so, for most taxpayers, tentative minimum tax will be lower than regular tax, and no extra amount will be due.   

There are a number of specific ways in which AMT taxable income differs from regular taxable income.  Having children may trigger AMT because dependents, child tax credits, education credits, dependent care credits, and other credits, are not allowed as offsets to AMT taxable income.  The 70% of taxpayers who claim the standard deduction may also be affected, since the standard deduction isn’t allowed under the AMT.  Other items that are deductible for regular tax, but not AMT, include:  property and state taxes, interest on 2^nd mortgages (used for purposes other than to buy, build or improve your home), medical expenses, unreimbursed employee expenses, and other miscellaneous itemized deductions.   In certain situations, long-term capital gains can also trigger AMT.  Some other “AMT triggers” that actually do affect wealthier taxpayers (as originally intended) include: tax exempt interest, incentive stock options, rental real estate, depreciation, and tax shelters.

Unfortunately, the complexity of AMT means that there is no simple test to see if it will be owed.   To determine AMT liability, the taxpayer must complete IRS form 6251, a very tedious and complicated tax form.  According to the IRS’s Taxpayer Advocate, figuring and keeping records to complete this form may take an extra 12 hours.  Additionally, many other tax forms may be required, such as Form 8801, Credit for Prior Year Minimum Tax.  Neither of these forms is included in the 1040 tax package mailed each year to taxpayers, but they should be completed every year.  Most tax forms can be obtained online at www.irs.gov or ordered over the phone from the IRS.

The Jobs and Growth Tax Relief Reconciliation Act of 2003, signed into law several years ago, was estimated to be the third largest tax cut package in U.S. history.  This Act was projected to save American taxpayers $350 billion over a ten-year period.   Unfortunately for many of us, the AMT will at least partially displace the benefit of these rate reductions.  According to the Urban-Brookings Tax Policy Center, there is now a better chance of paying AMT if you are in the upper-middle class than if you are rich.  Not only might you pay more, but you’ll get a migraine trying to figure out whether or not you owe it.   The tax is not working the way Congress originally intended, and treats having children and living in a high tax state as though they were tax shelters designed for the wealthy.   Still, with good tax planning and strategies, the AMT can be avoided or at least reduced, especially when the AMT results from employee stock options, unreimbursed employee expenses, or capital gains.  It would be a good idea to call your CPA before exercising any incentive stock options or getting a home equity loan so he or she can do the math.  Figuring AMT can consist of many “what if” scenarios.   People and congress are becoming aware of the AMT problem and there is even a website for reforming it: http://www.reformamt.org.  While it might be a nice idea to write your congressman about reforming the law, until it is corrected, look out for it!

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