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“A fine is a tax for doing wrong.
A tax is a fine for doing well.”
--Anonymous
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Alternative Minimum Tax
Did you check to see if you owed alternative minimum tax (AMT)?
The last thing you expect to see when you fill out your tax return is that you owe AMT. In fact, most people don’t even bother to check. If it turns out you should have paid the AMT but didn't, you will owe the back taxes plus interest or penalty.
Millions of taxpayers have been snagged by this nasty tax law in recent years. While only 19,000 people owed AMT in 1970, 2.6 million are paying it now, according to the IRS. And it is estimated that a third of all U.S. taxpayers (about 36 million) will owe AMT by 2010.
AMT is a separate tax system designed in 1969 to prevent the rich from avoiding income taxes. What happened? Inflation mostly. While the "regular" tax brackets, exemptions and standard deductions are adjusted annually for inflation, the AMT brackets and exemptions are not. So many people whose income has grown with the economy enter the dreaded AMT zone each year. Especially vulnerable are people with income over $75,000 and some large deductions, but not the exotic ones that were originally targeted by the AMT's creators. Most vulnerable are taxpayers with several children, interest deductions from second mortgages, capital gains, high state and local taxes, and incentive stock options.
To understand AMT, we must view it as a separate tax system. It has its own set of rates and rules for deductions, which usually are less generous than the regular rules. Because of these confusing rules, the only way you can tell if you owe the tax is by filling out the forms (essentially doing your taxes a second time) or by being audited by the IRS.
You should definitely run the numbers if your gross income is above $75,000 and you have write-offs for personal exemptions, taxes and home-equity loan interest. Ditto if you exercised incentive stock options during the year, or if you own a business, rental properties, partnership interests or S corporation stock. If you earn more than $100,000, run the numbers for that reason alone.
That means filling out Form 6251. In effect, you are simply adding back some tax deductions and income exclusions to your regular taxable income to arrive at your alternative minimum taxable income. This is what hurts the middle class. First you have to add back your personal and dependent exemption deductions ($3,050 each in 2003 and $3,100 each in 2004), then your standard deduction if you don't itemize ($9,500 for married filing jointly (MFJ) in 2003 and $9,700 in 2004; $4,750 for singles in 2003 and $4,850 in 2004). You also lose your state, local, foreign-income and property tax write-offs, as well as your home equity loan interest, if the loan proceeds are not used for home improvements.
AMT also ignores some itemized deductions, such as investment expenses, employee business expenses, and some medical and dental expenses. It counts as income the interest from private activity bonds, a type of tax exempt bond issued by governments, usually to finance sports stadiums, etc. Finally, AMT rules force you to pay taxes on the difference between the market price and the exercise price of incentive stock options granted by your employer. For example, if you exercised an option to buy 100 shares of stock for $3 a share and the stock was trading at $10, the difference would be $7 a share, or $700. Under the regular rules, you wouldn't pay current taxes on that amount, but under AMT, it's considered income.
You do get a few small breaks under AMT rules that you wouldn't see under the regular tax rules. For example, while you can't deduct state, local and foreign taxes under AMT rules, you can deduct the refunds, which would be considered income under the regular tax rules. And because you're taxed on the spread on your incentive stock options, your tax basis for the shares you bought is higher under AMT, meaning your tax bill will be lower when you sell the shares.
The AMT form has quite a few other pluses and minuses, but you can probably ignore them unless you own a business, rental properties or interests in partnerships or S corporations. If you do, you may need a tax pro to prepare your return.
Finally, you get to deduct the AMT exemption ($58,000 for MFJ in 2003 and 2004, and $40,250 for single). The AMT exemption amount returns to pre-2001 tax law and drops back to $49,000 for MFJ and 35,750 for single after 2004. Then this exemption is reduced by 25 cents for each dollar of AMT taxable income above $150,000 for couples ($112,500 for singles), and it's not adjusted for inflation, which is one reason why more people owe the AMT every year.
After the exemption has been deducted, the result is subject to AMT rates - 26% on the first $175,000 and 28% on the excess. Again, the AMT brackets are not adjusted for inflation, which causes much greater exposure to the tax as the years go by. If the AMT exceeds your regular tax, you have to pay the greater amount. Technically, the AMT is just the liability over and above the regular tax, and this figure is entered on page 2 of Form 1040.
People get pushed into the AMT zone for different reasons, and some are actually better than others. You could be eligible for the minimum tax credit, which allows you to claim a credit on your tax return in future years for some of the extra taxes you paid under AMT rules. You have to fill out another document, Form 8801, to determine if you are eligible. For whatever reason, the tax rules say that exercising incentive stock options is one of the few things that qualifies you for the credit, so if that's the reason you ended up paying the AMT, pay special attention to this form.
AMT tax is very complicated. You probably need to contact a tax professional.
Tax Savvy is here to make sure you pay only the tax required by law.
I received the following AMT article from RIA Tax Research July 22, 2005
Study finds AMT will snare more middle and upper income taxpayers than high income taxpayers
A CRS (Congressional Research Service) Report for Congress titled "The Potential Distributional Effects of the Alternative Minimum Tax" concludes that absent legislative action, the number of middle-to-upper-middle-income taxpayers affected by the AMT will increase significantly in the near future. In 2004, only 3 million taxpayers were subject to the AMT, but that number will grow to about 21 million in 2006. The most surprising aspect of this Report is its conclusion that the AMT will snare more middle and upper income taxpayers than high income taxpayers, especially those with adjusted gross incomes (AGIs) over $500,000.
Why the big jump in affected taxpayers? The regular-tax brackets, standard deductions, and personal exemptions are indexed for inflation, but the AMT brackets and basic exemptions are not. Additionally, the 2001 and 2003 reductions in the regular income tax further narrowed the differences between regular and AMT tax liabilities. The effects of the AMT were temporarily mitigated through an increase in the AMT basic exemption. For 2005, the AMT exemption is $58,000 for joint returns and $40,250 for unmarried taxpayers, but for 2006, unless there's a law change, these amounts will drop down to $45,000 and $33,750 respectively.
Who will be hit by the AMT? The CRS Report concludes that:
Married taxpayers filing joint returns will be more likely to fall under the AMT than others because prior legislation gave them more generous reductions in their regular income tax liabilities than did other filers. As a result, at any given income level, joint filers have seen their regular income tax liabilities reduced to levels that are near or actually below their AMT liabilities.
Larger families will be more likely to fall under the AMT than smaller ones. That's because personal exemption deductions are not allowed under the AMT.
Taxpayers who itemize their deductions and claim large itemized deductions for state/local taxes (especially those residing in high-tax states like N.J., N.Y., Conn. and Cal.) will be more likely to fall victim to the AMT than other taxpayers.
In 2006, even non-itemizers will be subject to the AMT at relatively modest income levels (e.g., joint filers claiming four personal exemptions will be subject to the AMT when their incomes exceed $67,500; joint filers claiming two personal exemptions will be subject to the AMT when their incomes exceed $76,500).
High-income taxpayers need to worry the least. The CRS Report analyzes statistics from the Congressional Budget Office and concludes that although the AMT was originally intended to make sure that high-income taxpayers paid at least a minimum amount of federal income taxes, they will not be the group that will be hit the hardest by the AMT. Here's why:
(1) High-income taxpayer face higher regular tax marginal rates than under the AMT (the top two marginal income tax rates are 33% and 35%, but the top AMT rate is 28%).
(2) The AMT disallowance of personal exemptions does not affect high-income taxpayers whose personal exemptions are phased out under the regular income tax.
(3) The basic AMT exemption begins phasing out for taxpayers filing joint returns when AMT taxable income exceeds $150,000. Consequently, many high-income taxpayers don't get a basic exemption under the AMT, and the scheduled reduction in the basic AMT exemption will have no effect on their AMT liabilities.
(4) High-income taxpayers generally derive a significant percentage of their total income from capital gains and dividend income. Under both the regular income tax and the AMT, the tax rate on long-term capital gains and dividend income is limited to a maximum rate of 15%.
I received the following AMT article from RIA Tax Research September 9, 2005
CRS updates report about tax revenue impact of changes to AMT:
Modifications to the alternative minimum tax (AMT) "will prove costly in terms of forgone revenue,"
the Congressional Research Service (CRS) said in an updated report on the subject that was issued on Sept. 2.
As described by the CRS, the AMT for individuals was enacted to ensure that all taxpayers, especially
high-income taxpayers, paid at least a minimum amount of federal taxes. Reliable long-term (beyond 2010)
revenue implications of modifying the AMT require specifying whether it is assumed that the 2001/2003 tax
cuts are allowed to expire after 2010 as scheduled or whether it is assumed that the tax cuts are extended,
the report said. While allowing the tax cuts to expire will reduce the costs of modifying the AMT, extending
the cuts beyond 2010 will see the costs of modifying the AMT "increase dramatically," CRS said, adding that
an extension of the 2001/2003 tax cuts would see those costs "almost double."
Relying on statistics compiled
by the Joint Committee on Taxation, the Congressional Budget Office (CBO) and the Treasury Department, the
CRS report included the revenue costs of modifying the AMT based on a number of policy options. For example,
maintaining the higher exemption levels currently in place and indexing the AMT for inflation would cost $191
billion during the period of fiscal years 2006-2010. It would cost $385 billion during FYs 2006-2015 if the
tax cuts are allowed to expire, while extending the cuts would have a price tag of $642 billion for the same
10-year period.
Allowing AMT taxpayers to take personal exemptions and either the regular standard deduction
or their itemized deductions for state/local taxes would reduce revenues by $282 billion during FYs 2006-2010.
The costs would be $530 billion over 10 years if the 2001/2003 tax cuts are allowed to expire. No 10-year figures
are available for this option if the tax cuts remain in place.
Repeal of the AMT would be the most expensive
policy option, the CRS report said. Citing CBO figures, the report said that repeal would cost $337 billion
from FY 2006-FY 2010. The 10-year costs would be $611 billion if the tax cuts expire and $1.16 trillion if the
tax cuts are extended. The report concluded by noting that Treasury has estimated that by 2013, it would be less
expensive to repeal the regular income tax than it would be to repeal the AMT.
The information you obtain at this site is not, nor is it intended to be, tax advice. You should consult a licensed tax professional for individual advice regarding your own situation.