Beware: You're In The AMT Now

[NATO AIR]

Good advice for those affected by the AMT...

http://www.businessweek.com/bwdaily/dnflash/feb2006/nf2006026_9914_db016.htm?campaign_id=rss_daily

FEBRUARY 6, 2006

NEWS ANALYSIS
By Howard Gleckman

Beware: You're in the AMT Now
This year thousands more American taxpayers will be caught by the alternative minimum tax. Here's what you need to know

You are ready for tax season. You've got your tax-preparation software loaded and your two-inch-thick stack of paperwork ready. You start plugging in numbers -- and suddenly get a warning: You may be subject to the alternative minimum tax. "What's that?" you ask. Advertisement

Well, the AMT is the mystery tax that can cost you thousands of dollars. Many more American taxpayers will find themselves in the AMT camp for tax year 2005. People often don't even know they're being hit until they do their returns. You can be pushed into it by a spike in earnings for the year, or by moving from a low-tax to a high-tax state, or even by having triplets or quadruplets. And even with advance warning, there isn't much that most people can do about it.

Here, in Socratic Q&A form, is a look at the dreaded AMT and what you need to know about the nastiest tax of all.

What is the AMT?
Think of it as a parallel tax universe. First you do your taxes the regular way. Then you refigure the whole thing under the AMT -- and you pay the higher of the two.

Who gets hit?
Mostly middle-class and upper-middle-class families who live in high-tax states. If you are making between $100,000 and $200,000, you're in the bull's-eye. Bill Gale, co-director of Urban-Brookings Tax Policy Center, says the typical victims are "the cop and the nurse with two kids." The typical extra ding: more than $3,000. On Apr. 15, about 4 million families will have to pay the AMT. Curiously, the rich are not hit as hard.

Why is that?
In part, that's because those personal exemptions are such a small share of their income. After all, if you're making $5 million a year, you're not going to care much about losing a $3,200 personal exemption or two. The other reason is the curious way capital gains are treated. If you're in the AMT, it turns out that you'll pay a much higher rate on your investment gains if you make $100,000 than if you make $1 million. It's just the way the AMT is structured. Nobody said it was fair.

So, how is the AMT different from the regular income tax?
The biggest difference is the way your deductions are treated. Under the AMT, you lose your ability to take some big deductions, including those for state and local taxes and the interest you pay on certain home-equity loans. You also will owe tax on certain kinds of municipal bonds, which are normally tax-free, and even on some big-ticket health-care costs. You also lose the benefit of your personal exemptions ($3,200 per family member).

Is that it?
Oh, no. You do get a special deduction that starts at $58,000 for a couple or $40,250 for a single. But this deduction gradually phases out for those with higher incomes. Then you figure out your tax rate. You pay 26% on your first $175,000 of AMT income and 28% on anything more than that. Want to know more? It's all there on Federal Form 6251.

How can I tell if I might get hit?
Commercial tax software can help you figure out whether you'll owe the AMT this year, and warn you about next year's liability. So can your professional tax preparer, of course. You can also go to the Internal Revenue Service Web site. They've got a new tool, called the AMT Assistant, to help you figure it out in advance. But, remember, the AMT is a little like the Mafia. Once you're in, you're in for life. Unless your personal or financial circumstances change radically, if you got hit last year, you'll get zinged again this year.

I hear that more people are now in danger of paying the AMT. Is that right?
Unfortunately, it is. Two reasons: One is inflation. That AMT exemption doesn't automatically increase to keep up with prices and wages. So, if you get a raise, your higher income may throw you into the alternative tax. Congress could fix this by increasing the exemption, but it hasn't done that yet for 2006 -- the taxes you'll pay in 2007. The other reason is the big tax cuts most of us got starting in 2001. Those rate cuts and other tax benefits lower our regular tax, but throw more of us into the AMT.

Is there anything I can do about it?
Not much, short of moving or giving up your kids. You can do a little planning around the edges. For instance, if you think you're going to be in the AMT, you can accelerate some income, or put off deductions to boost your regular tax liability. That's the opposite of what you usually want to do, but it may keep you out of the AMT for a year. Other than that, there isn't much.

Is there anything Washington can do about it?
Congress could repeal the AMT. But that would increase the national debt by more than $1 trillion over the next 10 years. That's why it's such a nasty problem