Alternative Minimum Tax
Waiting for Another
alternative minimum tax (AMT) was originally enacted to make
sure high-income people who take advantage of multiple tax
breaks don't escape paying tax to Uncle Sam. These days,
however, middle-income folks are the most likely AMT victims —
and the situation is getting worse every year.
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
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
who paid or are projected to owe
than 18 million if Congress doesn't act to provide
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
breaks are cut back
under the "regular" tax rules long before getting to the
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
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
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
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
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
in a new report, the bipartisan President's Advisory Panel on
Tax Reform calls the AMT a "complex, unfair, and inefficient
burden on millions of Americans" — few of whom were the
intended targets of the tax.
For the past
few years, Congress has applied an AMT patch or fiscal
band-aid that limited the number of middle income Americans
hit by the tax. But the patch ends on December 31 of this
year. The House and Senate both passed proposed legislation
that would apply a new AMT patch for 2006 but lawmakers were
not able to agree on a final version before they recessed for
What happens now? Many political
observers expect the AMT patch to be passed by Congress next
year and made retroactive to the beginning of 2006. There's
still time because taxpayers won't actually have to file 2006
returns until April of 2007.
In the meantime, check
into whether the AMT could apply to you. This article explains
how the complex tax works and some ways you might be able to
A Separate System
Think of the AMT as a separate system that
resembles the regular tax system. One difference is the AMT
system taxes certain types of income that are tax-free under
the regular tax system and disallows some regular tax
deductions and credits.
For 2005, the maximum AMT rate is only 28 percent, versus 35
percent under the regular tax system. Also, you are allowed a
relatively large AMT exemption equal to $58,000 for joint
filers, $40,250 for unmarried persons, and $29,000 for married
filing separate status. Unfortunately, the exemption is phased
out when your AMT income surpasses certain levels.
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
Large deductions for state and local income
and property taxes and home equity loan
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
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
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
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
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
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.