Taxing a Few Turned Into Taxing Many

Earlier this year, a bipartisan group of senators introduced a bill that would eliminate the alternative minimum tax, or AMT, as of this year.

“Years ago when many people abused generous tax loopholes, the AMT was designed to have the ‘wealthy’ pay at least a minimum tax,” says Robert Maloy, a partner of the accounting firm Bartlett, Pringle & Wolf, LLP. “However, today the AMT is trapping many people for which the code was never intended.”

When originally introduced in the Tax Reform Act of 1969, the tax was intended initially to target 155 high-income taxpayers who were paying little or no tax. However, according to the Congressional Budget Office, it is estimated that for 2006, 34.6% of taxpayers in the $50,000 to $100,000 adjusted gross income range will owe AMT and by 2010, 34% of all individual filers who pay income tax will be subject to the same tax.

AMT is a parallel tax system that has its own set of rules for allowable deductions, credits and exemptions (one for corporations and one for individuals). Certain items are treated differently for AMT reporting versus regular tax and it requires an adjustment. In essence, it sets a minimum tax rate of approximately 27% impacting a laundry list of preference items. A partial list of impacted items include:

• State and local taxes

• Medical expenses

• Certain tax exempt income

• Accelerated depreciation

• Passive investment offsets

• Certain credits

• Personal exemptions

• Standard deduction

• Certain home mortgage interest

• Investment interest deductions

• Incentive Stock Options (ISOs)

According to government reports and estimates, AMT for last year may generate as much as $24 billion in revenue, compared to $1.6 billion in 1990.

“Going forward, without an ‘extender’ or another law change, 2007 does not look any better for taxpayers who find themselves having to pay the AMT,” Maloy says. “And with the most recent change to the political landscape in Washington coupled with a significant government deficit, true relief is a real question.”

For people who live in wealthier communities with higher property taxes and steep state tax rates, like Montecito, AMT disproportionately hits those areas. California is one of the hardest hit states because of the combination of state tax rates and expensive real estate with high property taxes, the two major triggers for AMT.

Other parts of the country are not impacted by the AMT as much as California. States such as Florida, Texas and Nevada do not have state income taxes and much of the heartland of the country does not have high-priced real estate the level of California.

To make matters worse, if AMT is reduced, then what is put in its place? The Center on Budget and Policy Priorities estimates that repealing the AMT, while assuming that the tax cuts of 2001 and 2003 are made permanent and without further tax increases, would add $1.2 trillion to U.S. debt over the next 10 years.

What You Can Do

How do you know if you are impacted by the AMT and what can you do about it? “Unfortunately, AMT is a rather complex field with many variables and there is usually no simple answer or solution,” says Maloy. Per the IRS, in order to determine whether you owe AMT, you need to: complete a 16-line worksheet; read nine pages of instructions; and complete a 55-line form.

As a general rule of thumb, most households with incomes below $75,000 are rarely subject to AMT. However, if AMT remains un-indexed in future years, this may not be the case.

“For those currently or possibly in AMT, the probable answer to avoiding it going forward will be to have less preference deductions on the Schedule A,” says Maloy, referring to the tax form. “The largest two items on that schedule are typically state income and real estate tax payments. If someone is borderline AMT, it may behoove them to better time their property and state income tax payments along with doing longer term strategic tax planning.”

Before you make any future strategic decisions, just remember that it is always wise to seek proper guidance “ahead of time” to help maximize results by incorporating advice from your CPA and other financial advisors.