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Is The Alternative Minimum Tax In Your Future?
The
alternative minimum tax originally was designed as a parallel tax system to the
regular income tax to ensure that higher-income taxpayers who take a lot of
deductions pay at least a minimum amount of tax. [GAO
Report, computer file] But in recent years, the AMT has started snaring
more middle-income taxpayers. The latest Internal Revenue Service figures showed
828,000 taxpayers paid the AMT in 1998—up 25 percent from the year before. A
full quarter of those taxpayers reported adjusted gross income below $100,000.[WSJ,
6/28/00]
Unless
Congress adjusts how the AMT is calculated, extends current AMT tax credits or
eliminates the tax as some have proposed, 1.3 million taxpayers in 2000 and 17
million taxpayers in 2010 will pay additional tax under AMT, according to the
latest Treasury Department estimates.
[GAO] Taxpayers most
likely to trigger the AMT are those taking large deductions in relation
to their income, people who have high state or local taxes, taxpayers who have
high employee business expense deductions, and people exercising qualified
incentive stock options. Are you vulnerable to the AMT—if you’re not paying
it already—and what can you do to avoid or minimize it?
First,
let’s look briefly at how the AMT works. Taxpayers first calculate their
regular income tax. If there’s any question that they may be vulnerable to
AMT—tax preparation software will flag this, for example—then they should
recalculate their taxes under AMT.
When
calculating AMT, you add back certain adjustments and “preferences” that you
took when computing the regular income tax. For example, a taxpayer cannot take
the standard deduction under AMT. Taxpayers who itemize must add back such
adjustment items as the personal
and dependent exemptions, state and local taxes (including property taxes),
investment interest expense, child care credits, some home equity loans, [Mutual Funds, Jan 2000, p71] and that portion of home
refinancing that’s higher than the refinanced debt. Charitable deductions and
home mortgage interest don’t figure into AMT.
One
of the biggest triggers to AMT these days occurs when taxpayers exercise their
qualified incentive stock options. Under regular income taxes, you don’t owe
any taxes on the spread between the market price and the exercise price until
you sell the shares. However, under AMT that spread is treated as income.
After
the adjustments and preference items are added back, you basically get to take a
single allowable exemption. In the case of married taxpayers filing jointly,
it’s $45,000 ($33,750 for singles, $225,000 for marrieds filing separately).
However, these exemptions phase out once your alternative minimum taxable income
(AMTI) reaches $150,000 on a joint return or $112,500 IRS Form 6251]on a single return.
After
the exemption is taken (if you qualify), the first $175,000 of AMTI is
multiplied by 26 percent, and anything above that is multiplied by 28 percent.
If the resulting tax is higher than what you calculated on your regular income
tax, you pay the higher AMT amount. Thus, although the tax rates are lower than
the top rates for regular taxpayers, more income is exposed to tax under AMT so
the total may actually be higher.
Why
are an increasing number of taxpayers, including more middle-income taxpayers,
vulnerable to the AMT? For one thing, the exemption amount and the AMTI amounts
aren’t indexed for inflation and haven’t been adjusted in several years.
Taxpayers also are piling on more deductions in the wake of such tax acts as the
1997 Taxpayer Relief Act, creating a bigger spread between deductions and
income. For example, personal tax credits such as the $500 child credit and
higher education tuition credits are temporarily exempted from AMT, but only
through the 2001 tax year.
[GAO report, computer]
Now
is the time to start to work with your tax advisor to see if you’re vulnerable
and to take possible corrective actions. Planning is especially important
because tax strategies used to reduce regular income taxes, such as deferring
income and accelerating expenses in a given year, can have the opposite effect
on AMT taxes. Also, plans to exercise stock options warrant a close look. It may
be better to exercise before or after the end of the year, depending on your
circumstances. However, one should always be cautious about basing investment
decisions too heavily on tax law.
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