Tax Tips
Alternative Minimum Tax- January 2001
Richard Scrivanich - Partner
The AMT: It may be closer than you think.
Every year, more and more taxpayers are finding out the hard way that the Internal Revenue Service Code considers them wealthy. This is due to a not widely understood tax provision called the Alternative Minimum Tax (AMT). The AMT was created 30 years ago, after it was disclosed that some wealthy people were able to avoid paying any federal income tax because of various tax shelters, credits, deductions, etc. Today however, the AMT is snaring more middle-income taxpayers and is sometimes called a "stealth tax" because it catches many taxpayers unaware.
Why the AMT is a growing problem.
The AMT did not begin reaching the middle class until 1986 when the tax code was overhauled, most tax shelters were eliminated, and tax rates were lowered. To offset revenue stream reduction from the tax overhaul, personal and dependent exemptions and some medical expenses were counted as personal preferences and therefore subject to the AMT. In addition, unlike the regular income tax, the AMT is not indexed for inflation, so more middle class taxpayers are being pushed into the AMT. Over the next ten years, the AMT will affect 11.6 million taxpayers, and will grow most quickly among taxpayers with adjusted gross incomes of $30,000 to $75,000 a year.
How the AMT is computed.
The AMT is computed by applying a separate tax rate, usually 26% or 28%, to your regular taxable income. However, prior to applying the separate rate, your taxable income is modified by eliminating certain deductions, adding or subtracting various tax preferences and adjustments, and reducing or eliminating most credits. The AMT is computed separately from your income tax liability and has its own forms. Here are some of the most common deductions not allowed when computing the AMT:
- Personal exemptions.
- State and local income taxes.
- Property taxes.
- Miscellaneous itemized deductions.
- Medical expenses that do not exceed 10% of adjusted gross income.
- Interest expenses on mortgage debt on a first or second house, if it was incurred after June 30, 1982, and the proceeds of the debt were not used to buy, build, or improve the residence.
In addition, the timing of certain preferences and adjustments for items, such as depreciation and passive activities, are affected. Generally, they will increase AMT income in earlier years, but decrease AMT in later years or when the asset is disposed of or sold.
For long-term capital gains, the AMT cannot tax the gains at a higher rate than under the maximum regular long-term capital gains rate.
AMT rates and exemption amounts.
If you are subject to the AMT, a certain amount of income will be exempt. The exemption amount under the AMT depends on filing status and is completely allowed, but once certain income amounts are reached the exemption begins to phase out. After certain income levels are surpassed, the exemption completely phases out.
How you can avoid the AMT.
Even if you think you don't have a substantial amount of deductions or credits, you can unknowingly fall into the AMT. For example, you may have a large family or high medical bills for one of your children, thus causing you to exceed the exemption amount of your tax status. Or suppose you prepay a large chunk of state and local taxes, you may reduce your tax bill so that your tax payments under the regular tax are less than that under the AMT. If this happens, you can permanently lose the federal tax savings from these deductions. Before paying you may want to calculate your regular tax and the AMT. By postponing payments of estimated state and local income taxes until the following year, you may be able to avoid the AMT.
If you have any questions concerning the AMT, or any other question for that matter, please feel free to give me a call at (562) 698-9891.
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