Escape the AMT Trap

The brouhaha in Washington, DC, in the final weeks of 2007 over the alternative minimum tax ultimately ended with the eleventh-hour passage of a one-year patch, meaning Congress will be back to debate the issue come tax season next year. The debate did, however, highlight two key points: The tax remains as controversial as ever, and it will impact an ever-growing number of people unless politicians revamp it entirely.

The insidious thing about the AMT is that traditional tax planning—maximizing deductions, deferring income and so on—only increases your odds of getting hit by this one. The AMT was developed by the IRS in the 1960s as a way to make sure the überrich, who were increasingly managing to avoid taxes, paid something each year. Everyone was thenceforth required to calculate both the traditional tax system and the AMT, and pay which-ever was higher. But nobody bothered to index the AMT thresholds for inflation, so what was designed for Richie Rich has become a worry for Blondie and Dagwood.

If you have lots of personal exemptions, a large number of deductible medical expenses or miscellaneous itemized deductions, you might find yourself in the government’s AMT cross hairs. Check the online work sheet at irs.gov/individuals (click on "Alternative Minimum Tax Assistant for Individuals") to see if you're in danger of getting hit. The 2008 rules aren't likely to be up any time soon, but you can run through last year's work sheet using assumptions about what will be on your 1040 this year.

If it looks like you're in the AMT red zone, you'll enter the bizarro world of tax planning where everything is upside down. The goal in this game is to push or pull deductions into non-AMT years, whether it's this year or next. State and local tax payments, for example, won't do you any good this year if you expect to pay the AMT. So defer the payments until next year—even if it costs you some underpayment penalties. Unreimbursed medical expenses have a higher value in non-AMT years, too. So accelerate or defer paying some of those bills to a time when they'll do you more good.

The area you might have the most control over is miscellaneous itemized deductions. If you run the IRS test and it looks like you might need to pay the AMT this year, push off as many of the tax-saving strategies as possible into next year. (They won't do you any good in a year you pay the AMT anyway.)

The key, as with so many personal finance issues, is simply not to be taken by surprise.

—By Scott Bernard Nelson

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