High-income taxpayers should plan years ahead

Published: November 6, 2005

Mention the Alternative Minimum Tax and higher income taxpayers will cringe.

The dreaded AMT was part of the Tax Reform Act of 1969. Its catalyst was Treasury Secretary Joseph Barr who reported that in 1967, 155 individuals with incomes in excess of $200,000 (about $1.2 million today) paid no federal income tax. America needed money for the Vietnam War and Congress added the AMT with the intent that wealthy Americans should pay some tax.

President Bush's Advisory Panel on Federal Tax Reform stated early this year that the AMT "will catch almost four million taxpayers in 2005 and 20 million in 2006."

The U.S. Treasury also estimates that in 2005, 4 million Americans - 34 percent of taxpayers who earn between $200,000 and $500,000 - will pay the AMT.

In testimony to Congress last year, National Taxpayer Advocate Nina Olson estimated 30 million taxpayers will be subject to the AMT by 2010.

William Gale, deputy director and senior fellow in economic studies at the Brookings Institution, estimates 33 million Americans will have AMT liability by 2010.

"Households with income less than $100,000 will account for 52 percent of AMT taxpayers by 2010," said Gale.

Potential AMT liability can influence other planning activities. In traditional tax planning, taxpayers defer income and accelerate deductions and expenses.

But if a taxpayer may potentially have an AMT liability, the opposite strategy may be advantageous - for example, accelerate income and defer deductions.

The AMT taxable income is regular taxable income increased or decreased by adjustments, increased by preferences and without personal exemptions.

Taxpayers figure their federal income tax as they normally would. They then calculate their income tax using the AMT rules and rates.

State, local and real estate taxes, medical deductions and certain interest are added back, an exemption is deducted and the result is the AMT taxable income. Capital gains are normally taxed at 15 percent, but capital gains are a preference item and can trigger the AMT. The AMT tax rates are 26 percent on the first $175,000 and 28 percent over $175,000.

Taxpayers must learn to plan their taxes beyond the current year. Admittedly, that is tough to do, but tax planning for more than one year can reduce tax liability. If gains are to be recognized, consider also recognizing losses even if you like the investment with the loss. You can sell the loss security and buy a comparable security. Or wait 31 days to avoid the wash sale rule - which prevents you from claiming a loss on a sale of stock if you buy replacement stock within the 31 days - and re-establish your position.

Taxpayers can time their charitable contributions. Charitable contributions can be worth as much as a 35 percent at regular tax rates but only 26 or 28 percent at AMT rates.

Tax-exempt interest from private activity municipal bonds issued by local governments is disallowed for the AMT. Some municipal mutual bond funds invest in private activity bonds and interest paid by them retains its character. Selling private activity municipal bonds and replacing them with taxable bonds may result in less income tax.

Although the President's Advisory Panel has recommended that the AMT be deleted from the Tax Code, don't count on Congress to agree.