Levy for rich snares middle class

Flaw in plan means increasing numbers to be subject to AMT

Author: Andrew Caffrey

Published: April 14, 2005

A master's degree in tax law and a new marriage to a tax attorney didn't insulate Jennifer Bott from one of the tax season's biggest surprises: the alternative minimum tax.

Created to prevent the super-wealthy from paying no taxes, the alternative minimum tax is fast becoming an extra levy on the middle class and costing Bott and others several thousand dollars. And with the tax deadline tomorrow, there's little she and other taxpayers can do to avoid the tax.

Massachusetts taxpayers are particularly vulnerable to falling into the AMT, as it is known, because of higher state income taxes and municipal property taxes that trigger the AMT's thresholds. Also, exercising incentive stock options, a popular feature in the state's high-tech economy, can invite the AMT bite.

In 2003, 89,000 returns in Massachusetts, or nearly 4 percent of taxpayers, were subject to the AMT -- seventh-highest in the nation -- costing them an average of $3,829, according to an analysis of Internal Revenue Service data by the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, public policy groups in Washington, D.C.

By 2010, nearly one-third of all Massachusetts taxpayers will be paying the alternative minimum tax, according to Tax Policy Center codirector Leonard Burman.

The chief culprit is the exemption levels used to calculate AMT eligibility, which have largely not been updated for inflation; so as incomes and the value of many popular federal tax deductions rise, more and more people are being caught in the tax's web.

''It's an insidious tax. It never gets indexed, and it sucks more and more people in," said Robert Jacobson, the financial officer of a suburban construction company who has seen the AMT wipe out whatever refund he used to get from his federal returns.

The AMT is a method of calculating liability, requiring taxpayers to navigate a complex series of calculations to determine whether they're subject to the tax. Just the instructions for AMT form 6251 run to eight pages.

The AMT has lower tax rates than the top rates in the regular income tax system, but they are levied on a broader base of income largely because the alternative system has a smaller range of allowable deductions. In fact, what may surprise unsuspecting taxpayers most is that certain deductions, such as personal exemptions or property taxes, are added back to calculate tax liability under the AMT.

Bott and husband Kevin Long, also a tax attorney, estimate the AMT cost them around $5,000 in additional taxes. What particularly hurt, she said, is having to pay about $12,000 in property taxes in Sudbury, but not being able to deduct those local taxes from their federal return.

''That's the huge impact," she said.

An unexpected AMT bill of around $3,000 came at an inopportune time this spring for John Moody: just as he's spending thousands for a summer-abroad program for one of two college-aged daughters. A Duxbury resident, Moody was caught in the AMT for the first time in 2004 after a divorce changed his filing status to head of household, which is similar to single filing status in that it has a lower level of income exempt from AMT.

What galled him is being swept up by a tax supposedly for the rich. ''It's the principle of the matter," he said. ''It was never intended to affect people in my category."

Soon, the AMT will affect many more taxpayers lower on the income ladder.

By 2010, 16.9 percent of taxpayers with annual incomes between $50,000 and $75,000, and 53.4 percent of those between $75,000 and $100,000 would have to pay the additional tax, according to a 2005 study by the Tax Policy Center. Families would be particularly affected, because they claim the exemptions, credits, and deductions that are added back to calculate AMT liability. Nearly every married couple with two or more children and incomes between $75,000 and $100,000 will be caught in AMT.

Last month, IRS commissioner Mark W. Everson said the AMT is ''sort of horrific," and the National Taxpayer Advocate, Nina E. Olson, has called it the top problem facing taxpayers. Both have called for its elimination, and a new panel on tax reform appointed by President Bush indicated it will review the AMT.

Still, changing the AMT, derisively known as the ''Blue State" tax because it more often affects filers in states that vote Democratic, won't be easy politically -- or financially. According to the Tax Policy Center, it would cost the US Treasury less money by 2008 to repeal the regular income tax than to eliminate the AMT. Replacing those lost funds has become a huge challenge for fixing the AMT.

Planning around the AMT is hard. Generally, tax specialists suggest filers consider accelerating income and deferring deductions -- often the opposite of what many try to do to lower taxes under the regular system.

For example, Moody's accountant Eric Heshion of Cunningham, Macey & Heshion PC in Hingham, said filers who suspect they may be subject to the AMT should consider getting a year-end tax review from a professional to see whether their exposure can be minimized.

Also, taxpayers should carefully consider the timing of transactions, such as when to exercise incentive stock options.

But overall specialists said there isn't much taxpayers can do -- short of moving. ''I have a pretty plain vanilla return," said Long, the tax attorney, "and I shake my head and ask myself the same question: `What should I be doing differently?' I'm at a loss."