The Hated Alternative Minimum Tax (AMT)

By Nancy Zambell, Contributing Editor

Happy New Year!

We hope your holiday season was filled with joy, good health and lots of good food!  And while we hate to usher in the New Year discussing such a dreaded topic as the AMT, we thought it would be helpful to bring you up-to-date on the latest (and actually good) news about the AMT.

The tax resulted from the government discovering a loophole that allowed 155 taxpayers in 1966 to pay no tax on their income above $200,000.  In 1969, the Alternative Minimum Tax was created to close that loophole.  It was a stopgap measure to prevent taxpayers in the highest income tax brackets from abusing certain exemptions and deductions to completely avoid paying federal income tax.

However, because the tax was never adjusted for inflation, more middle- and upper-middle-level income folks are subject to it each successive year.  No question, the AMT has turned into the big bad wolf and today, affects over 25 million taxpayers, a number that is estimated to rise to more than 50 million by 2015.

That means the tax affects a lot of folks who are not rich, but just working hard to pay their bills and have a little left over to save and invest.

How Does AMT Work?

The name is derived from the alternative set of rules for figuring your income tax.  The rules were created to calculate your minimum tax owed. If you calculate your taxes the regular way and are already paying as much as the AMT says you need to pay, then you don’t have to pay AMT.  However, if the amount of your regular tax is less than that required by the AMT, guess what – you owe more money to the IRS!

Now, lest you think that the AMT is only levied on folks with lots of big deductions, think again.  The plain truth is that you can be subject to AMT even if you only have one big deduction or exemption, or even a bunch of little ones added together.  Even normal items such as a deduction for state income tax or interest on a second mortgage, or even your personal and dependency exemptions can make you a candidate for AMT.

According to Fairmark.com’s Tax Guide for Investors, the Top Things that Cause AMT Liability are as follows:

Exemptions claimed for yourself, your spouse and your dependents are not allowed when calculating alternative minimum tax, and the more you claim, the more likely it is that you will incur AMT liability.

Standard Deduction. According to Fairmark, approximately 70% of American taxpayers claim the standard deduction (rather than itemizing). And wouldn’t you know, the standard deduction isn't allowed under the AMT!

State and Local Taxes Deductions are not allowed under the AMT, and if you are a resident of an area with high state and local taxes, such as New Jersey, New York, Massachusetts, and Maryland, you're more likely to be subject to the alternative minimum tax.

Interest on Second Mortgages is only allowed for proceeds used to buy, build or improve your home.

Medical Expenses, while allowed under AMT, are more limited than the deduction under the regular income tax.  Part or all of itemized deductions for medical expenses will be disallowed under AMT.

Miscellaneous Itemized Deductions, such as unreimbursed employee expenses, tax preparation fees, and many investment expenses are disallowed under AMT.

Various Credits that are ok when filing your regular tax return are not allowed under AMT.  However, Congress has taken that into consideration in recent years, providing relief for these credits.

Income from Incentive Stock Options are required to be reported on AMT, although they are not required for your regular income tax reporting.

Long-Term Capital Gains receive the same preferential rate under the AMT as they do under the regular income tax.  Therefore, you would think that they shouldn't cause you to pay alternative minimum tax. However, in real life, they can cause a substantial AMT liability by reducing or eliminating the AMT exemption amount, which is designed to protect low-income taxpayers from having to pay alternative minimum tax.

Tax-Exempt Interest tax may or may not be exempt from the AMT.  The rules are complex and you should consult an attorney to help you determine whether they apply to you.  Fairmark.com reports that bonds that aren't exempt from AMT pay a slightly higher rate of interest to compensate for the fact that they aren't fully tax-exempt.  If you invest in them (or in mutual funds that purchase them), you will likely be subject to ATM.

Reducing your income via Tax Shelters was substantially reduced by the Tax Reform Act of 1986.  However, some still exist, and you need to know that the AMT will reduce those benefits provided by these investments.

For more information on AMT rules, please see:

www.fairmark.com/amt/index.htm

Well, it’s easy to see why the mere mention of AMT causes taxpayers to run for the hills! But…


Now, for the Good News!

Congress handed out a nice holiday gift to taxpayers on its last day of its 2007 session, approving legislation that prevents AMT from expanding its reach any further.  And in more good news, the President reported that he will sign this ‘AMT Patch’ legislation.

The House voted 352-64 for this one-year fix of the AMT.  Without it, those subject to the tax would have soared from 4 million in 2006 to about 25 million in 2007, with the average taxpayer shelling out an additional $2,000.

Pundits report that the main beneficiaries of this AMT relief would be folks earning from $75,000 to $200,000.

Here’s what it means to you:

The legislation comes in two parts.  The first extends a rule that prevents the AMT from eliminating certain educational tax credits, such as the Hope credit and lifetime learning credit.  The second increases the AMT exemption amount, a deduction allowed in the AMT calculation to make this tax apply only to higher-income taxpayers.

The deduction has ‘temporarily’ and gradually been increased each year of President Bush’s term.  But absent this new law, the 2007 exemption would have reverted to the 1993 level.  Instead, it will now go up a little from 2006’s level.

For married couples filing jointly, the exemption for 2007 will be $66,250 and for singles, it will be $44,350.

Because the IRS will now have to adjust tax forms and reprogram their computers, it is expected that early fliers may find their tax refunds delayed somewhat.  According to its website, the IRS says it anticipates that it will begin processing returns for most taxpayers by mid-January. But those approximately 13.5 million taxpayers using five forms related to AMT, will have to delay their tax return filing until the IRS completes the reprogramming of its systems, which it is currently estimating will be February 11, 2008.

According to their website, returns that include the following forms cannot be filed until February 11, 2008:

• Form 8863, Education Credits
• Form 5695, Residential Energy Credits
• Schedule 2, Form 1040A, Child and Dependent Care Expenses for Form
  1040A Filers
• Form 8396, Mortgage Interest Credit
• Form 8859, District of Columbia First-Time Homebuyer Credit

For more information from the IRS, please see:

www.irs.gov/taxtopics/tc556.html
www.irs.gov/pub/irs-pdf/f6251.pdf

So once more, a temporary bit of relief from AMT. Let’s hope this year that Congress will gain the courage to put the final nail in its coffin!

In the meantime, if you have any inkling that you may be subject to AMT, we recommend that you seek professional advice—just to be sure.

Happy Investing!

Nancy

This concludes this week's issue of Financially Fit.  We encourage you to visit our website to review past issues of Financially Fit:

http://www.brokeradviser.com/newsletter.cfm