Alternative Minimum Tax: Warning: This Trap Hurts

Author: Linda Stern

Published: December 1, 2004

The Alternative Minimum Tax is creepy, in both senses of the word. It?s scary, because it can blindside taxpayers with a bigger tax bill than they were expecting. And it?s creeping up on everybody. ?The day of reckoning is going to come,? warns James Seidel of RIA, a New York tax-research firm.

THIS YEAR ABOUT 2.4 million taxpayers will pay the AMT. By 2010, one in three taxpayers (and almost everyone earning more than $100,000) will be subject to it, according to the Tax Policy Center. High earners with certain kinds of write-offs-high local taxes or lots of kids, for example-could be on the bleeding edge.

The AMT is truly an alternative system, with its own set of rates, deductions and exemptions, and a whole separate form. Created in 1969 to snag the loophole-loving wealthy, it works like this: it exempts your first $40,250 of income ($58,000 for couples), adds back some regular write-offs (such as some home-equity interest, local and state property taxes and personal exemptions) and then applies a lower-than-your-usual tax rate (26 percent on the first $175,000; 28 percent on the rest) to the newly calculated income. Every year it claims more taxpayers, because regular tax rates have dropped and are indexed for inflation, while AMT rates and brackets remain unchanged. AMT and regular tax rates are converging, and without a fix from Washington, many families will get squished.

Many experts believe that fix will come before 2008, when the AMT would eclipse the regular income tax. But what to do now? If your taxable income is more than $100,000 and you plan to write off $20,000 or more with personal exemptions, home-equity interest, health-care costs or deferred gains on stock options, you could fall into the AMT trap. Turn traditional year-end planning on its head, suggests Seidel. Accelerate income, push deductible expenses into 2004, and hope somebody fixes the mess soon.