Watch
Out for This Tax Trap
The
alternative minimum tax (AMT) was originally established in 1969 to target 155
high-income taxpayers who had used deductions to completely avoid paying federal
income taxes.1 Since then, the AMT’s reach
has spread significantly, affecting many taxpayers for whom it was never
intended.
Where
Less Means More
Any tax called “minimum” may at first seem like a blessing, but more often
than not, being subject to the AMT means paying a higher tax bill. The AMT
typically targets taxpayers with sizable long-term capital gains and deductions
relative to their ordinary income. It prohibits any deductions outside of
charitable contributions and mortgage interest, including miscellaneous itemized
deductions, property taxes, and state taxes.
Those who may fall under the AMT must calculate their taxes twice, once under
the regular tax system and once under AMT rules. They must pay whichever bill is
higher.
Retirees
Behind the Eight Ball
For taxpayers who have considerable deductions compared to their ordinary
income, the AMT poses a significant threat. If you run a home-based business or
live in a high-tax state such as California or New York, sizable deductions
could put you in AMT range.
If the bulk of your income comes from long-term gains, this may also trigger the
AMT. Although the same long-term capital gains rate of 20 percent applies under
the AMT, substantial deductions could push your regular tax calculation below
the AMT floor. Income from a pension, dividends, or an IRA can help you avoid
reaching AMT territory.
No Relief in Sight
Recent tax breaks and the fact that the AMT is not indexed for inflation will
further stretch its reach in the coming years. Between now and 2010, the number
of households affected by the tax is expected to rise from 2.7 million to more
than 35 million.2
Though opposition to the tax is gaining steam, most experts agree that a repeal
is unlikely because of the amount of revenue generated by the AMT — between
$12 billion and $54 billion a year for the next eight years.3
The AMT is one of the most complex and grueling items in the tax code. But with
long-term planning and a proper tax strategy, you may be able to develop the
right approach for addressing its impact.4
1) Urban-Brookings Tax Policy Center, September 2002
2–3) The Wall Street Journal, September 30, 2002
4) Before you take any specific action, be sure to consult with your tax
professional.
©
2002 Emerald Publications
