Sunday, December 7, 2008

AMT Explained

Want to understand the true essence of pain? Watch the face of a taxpayer who completes a tax return showing a $2,000 refund. Then remind him of the Alternative Minimum Tax (AMT), and tell him it results in a net $3,000 in additional taxes owed. This is what is happening to more and more middle class Americans. However, with a good idea of what you’re up against, you can plan for the AMT and, I hope, avoid it entirely

How does the AMT work? Well, Congress designed the AMT in 1969. It's supposed to ensure that everyone especially the most affluent pays at least some tax. The AMT mandates a recomputation of your federal taxable income at a flat tax of 26%, and you are required to pay the higher of two tax bills. It becomes a flat tax of 28% on AMT taxable income over $175,000 for all taxpayers except those who file "married filing separately." For these taxpayers the 28% rate applies to income above $87,5000. The rate is applied on your income after your standard or itemized deductions but before your personal exemptions. Now, here is where the pain starts, the amount (line 37 on your 1040) is then increased by what are called “tax preferences.” and is reduced by an exemption amount that phases out as your AMT taxable income increases.

“Tax preferences” are nothing more than tax benefits or deductions that Congress has decided to give you under the regular tax system and then take away from you under the AMT tax system. Here’s what I mean. If you took the standard deduction, forget it. It’s a tax preference. Did you itemize? Medical expenses are normally deductible to the extent they exceed 7.5% of your adjusted gross income under the regular tax system but not for the Alternative Minimum Tax system. Under the AMT computation, you can only deduct the excess over 10% of your adjusted gross income. Forget the deduction for state and local income taxes or property taxes. They’re all tax preferences, and are added back into your AMT income. Congratulations if you live in a high income-tax state like New York or pay substantial real estate or personal property taxes! So watch out if your state is talking about increasing property or state taxes to close budget gaps. Do you itemize? Kiss your miscellaneous itemized deductions goodbye. That means investment expenses, tax preparation costs, job hunting expenses and all non-reimbursed employee business expenses lose their tax benefits.

By the year 2010 and probably regardless of the Bush tax cuts, the number of taxpayers affected by the AMT will rise to as many as 17 million, or about one in six. The revenue gain for the Treasury: from $5.8 billion a year to $38.2 billion a year. The reason more of us will be affected by the AMT in 2010 than now is that the AMT, unlike normal tax brackets, isn’t indexed for inflation. If it were indexed, as much of the tax code is, the projected increase would only be to 2.1 million taxpayers. Among the taxpayers increasingly exposed will be those with large families because of exclusions of such items as child credits. So plan, plan, plan!

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