Waiting for Another Patch

AMT Basics     In 1969, Congress enacted the minimum tax after learning that 155 taxpayers with adjusted gross incomes of $200,000 or more paid no federal income tax at all for the 1966 tax year. This chart shows the escalation of the tax: Year Taxpayers who paid or are projected to owe AMT 1970 19,000 1995 414,000 2005 3.5 to 4 million 2006 More than 18 million if Congress doesn't act to provide relief 2015 More than 50 million     Why doesn't Congress just permanently repeal the tax? Over the next 10 years, the AMT is expected to generate $1.2 trillion in tax revenue. Recouping the money would involve raising tax rates, eliminating tax breaks or both.

Why Middle Income Taxpayers Get Hit    After repetitive tax law changes, the AMT is no longer a factor for many high-income taxpayers because many of their tax breaks are cut back under the "regular" tax rules long before getting to the AMT calculation.     For example, if adjusted gross income exceeds certain levels, there are various "phaseout" rules that chip away or eliminate personal exemptions, most itemized deductions, credits, and other items. So high income people may have little or nothing left to lose under the AMT rules.     Also, the AMT exemption (similar to the regular standard deduction) is not adjusted for inflation. This doesn't have much impact on high-income earners, but makes middle-income taxpayers more likely to owe the AMT.

"The AMT is a salient example of a policy or government program gone astray with unintended consequences carrying malign impacts." — President Bush's Advisory Panel on Tax Reform, November 2005 report

The Corporate AMT     In addition to the personal AMT, the tax code also contains a corporate AMT. Here's what the President's Advisory Panel has to say about it:     "Like the individual AMT, the corporate AMT has been used to pare back, rather than repeal, tax benefits by partially penalizing businesses that claim tax incentives.     Under the corporate AMT, corporations are required to keep an entirely different set of books and records and to calculate their tax liability under two very different complex sets of rules — the regular income tax rules with rates up to 35 percent and the corporate AMT rules with rates up to 20 percent — and then pay the larger of the two amounts.     The corporate AMT is an accounting and administrative nightmare that requires businesses to recompute many deductions using less generous rules ... In addition, the corporate AMT may exacerbate economic downturns by making corporations that are realizing losses under the regular income tax pay additional taxes when they are losing money."

A Separate System

Computation of the AMT is extremely complex. Various factors make it difficult to pinpoint exactly who will be affected. But there are some common danger signs:

 Large families resulting in quite a few personal exemptions for dependents.

 Incentive stock options exercised during the year.

 Large deductions for state and local income and property taxes and home equity loan interest.

 Miscellaneous itemized expenses (such as investment expenses and unreimbursed employee business expenses) deducted for regular tax purposes.

 Large long-term capital gains.

 Medical expenses that you’ve deducted for regular tax purposes.

 Interest from “private activity bonds," which are tax-free for regular tax purposes but taxable under the AMT rules.

 Significant regular tax depreciation write-offs for personal property assets such as machinery, equipment, computers, furniture, and fixtures. These items must be depreciated using slower methods for AMT than for regular tax.

Planning Ahead

It isn’t easy to “plan around” the AMT. In fact, Congress carefully drafted the rules to curtail such moves. Even so, there is hope.

For example, any planning move that reduces your adjusted gross income (AGI) might help. Why? Because lower AGI means a better chance of claiming a bigger AMT exemption. Lowering your AGI also slashes your state and local income taxes, which are disallowed in computing the AMT.

The following are some ways to cut your AGI:

 Make a deductible IRA contribution if you qualify.

 Contribute the maximum amount to your tax-deferred retirement plan (Keogh, SEP, 401(k), etc.).

 Contribute more to a cafeteria benefit plan at work (contributions lower your taxable salary and thus your AGI).

 Prepay deductible business expenses near year-end if you run a business as a sole proprietorship, LLC, partnership, or S corporation. The deductions are “passed through” to you, resulting in lower AGI. Similarly, postponing the receipt of taxable income until next year also reduces your AGI.

 Take some year-end losses on investments if applicable. You can use the capital losses to offset capital gains, which reduces AGI. Any leftover capital losses, up to $3,000, are deductible against taxable income from all sources (such as Schedule C or E income, salary, interest or dividends). So your AGI is reduced even further.

 Consider deferring security sales that produce taxable gains until next year.

In addition, you should carefully time the exercise of any incentive stock options. Triggering these options when there’s a big spread between current market value and the exercise price is one of the most common causes for unexpected AMT bills.

Consult with your tax adviser if you suspect you may be subject to AMT. Smart planning can help you avoid or reduce the tax bite in future years.