How to Keep the AMT Menace at Bay
The tax code has many gremlins, but the alternative minimum tax is a monster that, like Freddy Krueger of the Elm Street movies, keeps terrorizing. And by relying on temporary half-measures, Congress has failed to rein it in.
Since a big deduction for local income and property tax is a common trigger of the AMT, people in areas where local taxes are relatively low and incomes and property values modest have been saferthough not immunefrom it, according to a new survey by the Congressional Research Service.
Among AMT havens are Alabama, Alaska, Louisiana, Mississippi, North Dakota, South Dakota, Tennessee, West Virginia, and Wyoming. In all of these states, less than 1 percent of taxpayers was subject to the tax in 2004.
Most likely to succumb are residents of jurisdictions with areas of high incomes and property values and relatively high taxesfor example, California, Connecticut, the District of Columbia, Maryland, Massachusetts, New Jersey, and New York, where about 4 to 5.5 percent of taxpayers paid the AMT.
With No Fix, Bite Will Only Get Bigger
But unless permanently checked by Congress, the AMT will confront millions of additional victims throughout the country. The number of taxpayers paying AMT has grown from about 1 million five years ago to about 4 million today. Without a permanent fix, government economists say the AMT could snare 23 million taxpayers in 2007 and 31 million by 2010entangling 90 percent of those with $100,000 to $500,000 in income.
The AMT requires a separate calculation of tax in addition to figuring normal tax. The AMT subjects more income to taxation because, in addition to state and local taxes, a number of other normal deductions and exemptions are not allowedfor example, personal exemptions for yourself and dependents, most home equity loan interest, and job and investment expenses. When the AMT exceeds your regular tax, you must pay the difference.
For those who pay AMT, the extra amount can range from hundreds to thousands of dollars. The likelihood of paying AMT varies with your specific situation, but generally susceptible are people with over $100,000 in income and large deductions. But even families with income under $100,000 can be hit if, for example, there are exemptions for a lot of children.
Reductions in regular tax rates and failure to index the AMT's bite to offset inflation have widened its reach well beyond the original aim of forcing high-income investors in tax shelters to pay a minimum amount of tax.
One barrier to dismantling the AMT is the lost tax revenue. Total repeal could cost $1.2 trillion over 10 years and require a 10 percent increase in tax rates if the government wants to make up the differenceboosting, for example, the current middle 25 percent rate to 28 percent, according to tax researchers.
There are limited ways to avoid or minimize the AMT for 2006. Professional guidance and hypothetical scenarios using tax software can be a big help.
Steps to Take
Some twists to keep in mind:
Don't rush to make estimated payments of state tax before the end of the year or prepay local property tax if you expect to be subject to the AMT for 2006. Those aren't deductible when figuring the AMT.
Job-related deductions aren't allowed for the AMT, so employees who deduct a lot of expenses could try to negotiate a salary reduction with their employer if the company will then directly cover the expenses.
Tax-exempt interest on "private activity" municipal bonds for government-sponsored commercial projects such as industrial parks, stadiums, housing, and such is not tax free when calculating AMT. That can affect an investment decision or enhance the appeal of an "AMT-free" bond mutual fund.
The tax savings from a home equity loan can evaporate if you are subject to the AMT since the interest isn't generally deductible, but here's an out: Interest on a loan to remodel your home is deductible for the AMT.
Capital gains aren't directly hit by the AMT, but those low-taxed boosts to total income could trigger the AMT. Advisers say timing the amount of such gains can ease the AMT impact.
Exercising an employee incentive stock option normally defers tax until the acquired shares are sold, but exercising an option can in some cases spark immediate tax under the AMT. Staggering the exercise of options over several years may lessen or avoid the AMT.