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Alternative Minimum Tax

 Waiting for Another Patch

The alternative minimum tax (AMT) was originally enacted to make sure high-income people who take advantage of multiple tax breaks don't escape paying tax to Uncle Sam.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.

AMT Basics

    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 the tax:
Year Taxpayers who paid or are projected to owe AMT
1970 19,000
1995 414,000
2005 3.5 to 4 million
2006 More than 18 million if Congress doesn't act to provide relief
2015 More than 50 million
    Why doesn't 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 both.

Why 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 their tax
breaks are cut back under the "regular" tax rules long before getting to the AMT calculation.
    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 rules.
    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

The Corporate AMT

    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 incentives.
    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 amounts.
    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 money."

In fact, 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 the year.

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 avoid it.

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.

Other differences: 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 year.

 Large deductions for state and local income and property taxes and home equity loan interest.

 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 AMT rules.

 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 regular tax.

Planning Ahead

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 qualify.

 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 your AGI).

 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 bills.

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. Ronald J. Cappuccio, J.D., LL.M.(Tax) 1800 Chapel Avenue West Suite 128 Cherry Hill, NJ 08002 Phone:(856) 665-2121 Fax: (856) 665-9005 Email:

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