Alternative minimum tax was designed to snare the rich, but it sneaks up on not-so-rich taxpayers

Author: Ken Berzof

Published: December 7, 2003

For some things to happen in life, it's just a matter of time.

Like a Republican being elected governor in Kentucky. Or the UK football team losing to Vanderbilt. Or the Red Sox and Cubs ... well, maybe next year.

And it may be next year, or just a matter of time, before you get snared by the alternative minimum tax, if you haven't already been bitten. This sneaky, complicated thorn of a tax was originally aimed at the wealthy. But these days it merits nearly everyone's attention, especially as they contemplate year-end tax planning.

"It's something everyone should look at," said Durbin Oldham, a certified public accountant with Cox & Oldham in Louisville.

There's no easy way to know if you're AMT material, but "a lot of average, middle-class people will be assessed the tax. It will catch a lot of people," said Mike Moorman, a CPA and financial planner for Kentucky Financial Group in Louisville.

You can do a few things before Dec. 31 to try to soften the blow of the tax, but you need to understand it first, then get two or three sharp pencils.

What the tax is about

The AMT was imposed around 1970 to prevent wealthy taxpayers from paying little or no taxes by exploiting deductions, credits and loopholes. As the name implies, it's an alternative way of computing your federal income-tax liability.

In effect, it eliminates certain deductions and credits and creates a tax liability for a person who would otherwise pay little or no tax by imposing tax rates of 26 percent and 28 percent. For example, personal exemptions for dependents and deductions for state and local taxes and interest on home-equity loans not used to buy or improve on a home are not allowed under the AMT. And while income from tax-exempt municipal bonds is generally exempt from federal taxes, some tax-exempt income might fall under the AMT's wings.

Essentially, you need to figure your taxes the normal way and under AMT rules. The additional amount you would owe under the AMT is included on its own line on Form 1040, based on its own Form 6251. Fun. fun.

Who gets caught?

The congressional Joint Committee on Taxation this year estimated about 2.4 million taxpayers will fall under the AMT spell this year, a number that could rise to 11.3 million in 2005.

Longer term, though - unless Congress changes it - many more people will be affected, according to the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution.

It predicted that by 2010, for all taxpayers regardless of filing status, the AMT could catch 37 percent of taxpayers with adjusted gross incomes of $50,000 to 75,000; about 73 percent of those with AGIs of $75,000 to $100,000; and 92 percent of those with AGIs of $100,000 to $200,000. More people will get caught primarily because the AMT is not indexed for inflation, meaning more people will be subject to the tax as their incomes rise, and because of recent tax-law changes that reduced the normal tax rates.

The AMT has its own exemption - $40,250 for single taxpayers and taxpayers filing as head of household; $58,000 for married taxpayers filing jointly and qualifying widow(er)s; and $29,000 for married taxpayers filing separately.

"It's a little tricky to predict in advance" if you'll be subject to the AMT, Oldham said. "Having several kids is just one factor."

Others factors that could trip you up: deductions for state and local taxes; certain miscellaneous itemized deductions, such as investment expenses; incentive stock options; and large capital gains.

What you can do

At this time of the year, "there's not a lot you can do" to stave off the AMT, said Oldham. But he, Moorman and other tax experts offer these suggestions:

Itemized deductions. Many Schedule A deductions will work against you for AMT purposes. Among the exceptions are charitable deductions, betting losses to extent of winnings from gambling, and interest on home-equity loans used only to buy, build or improve a first or second home.

Taxes. Because state, local and property taxes deducted on Schedule A are added back to your income in calculating AMT, it might be wise to delay your last quarterly estimated state income-tax payment until next year.

Along the same lines, consider delaying paying property taxes as well but, Moorman said, you'll need to evaluate whether the tax savings will be enough to forgo any discount you might get by paying property taxes early.

Capital gains. If you have large capital gains and are sure to pay the AMT, consider selling some investment losers to offset the capital gains.

But don't let the AMT overrule wise investment decisions, said Mark Luscombe, principal tax analyst for CCH Inc. of Riverwoods, Ill., which publishes tax information.

"Be careful about overreacting. You may be better off paying the AMT," he said. "In that sense, if you're subject to the AMT, it's probably a sign that you're doing some smart tax planning to begin with."

If you expect to sell land at a big profit, consider selling it on an installment basis, in which your gains could be spread over several years. But depending on your AMT situation, Moorman said, it may be worth it to sell it outright and get the tax over with.

Incentive stock options. People who exercise options to acquire stock and hold onto their shares are treading on thin ice with the AMT. For regular taxes, no income is recognized when an incentive stock option is exercised. But the AMT applies to the difference between the exercise price and the fair market value of the stock when bought, but not later sold.

So, Luscombe said, if you've exercised an option and still have the stock but are thinking about selling it anyway, selling sooner might help lower the AMT's bite.

Also, consider delaying the exercise of your options in the first place if the AMT looms.

Knowing you're safe

In general, it's difficult to know without professional consultation if you will be subject to AMT.

But there is at least one good way to tell for sure that you don't have to worry about it, Moorman said. "If your primary source of income is from salary and you don't have more than two or three kids, you should be pretty safe."

Everyone else is fair game. Go figure.