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Afraid of the AMT? Now's the Time to Get
Some Help
Unless Congress acts, the number of taxpayers hit by the
Alternative Minimum Tax (AMT) in 2007 will jump to about 23
million from about 4 million in 2006. The AMT is an alternative,
separate tax calculation created in 1969 to make sure the
wealthiest Americans paid a fair amount of taxes. The AMT is
applied to particular taxpayers' regular taxable income when
particular activities and deductions add up.
Basically, Uncle Sam wanted to keep taxpayers from writing
off their tax responsibilities forever.
But why is the AMT spreading lower and lower on the tax rolls
to the middle class? There are two reasons. First, since its
introduction in 1969, elements of the AMT have not been adjusted
for inflation while the regular income tax has. According to the
Tax Policy Center of the Urban Institute, this means that if an
individual's income tax just keeps up with the annual rate of
inflation, his or her income tax would remain constant in real
terms while the potential AMT liability would continue to
increase. Second, it's also important to note that since its
inception, the government has dropped the top tax rate from 70
percent at the start to 35 percent in this decade while the AMT
rate has risen by several percentage points. The intersection of
AMT and regular tax over the past 40 years is as much a story
of changing tax brackets as it is the adjustment of the
exemption amount.
The approaching election year might finally force some
permanent change on the AMT situation, but until then, it makes
sense to consult a qualified tax advisor or a Certified
Financial Planner™ professional on your risk factors for the
AMT. It's too complicated to fully explain here, so advice is
essential. There are many reasons people get pushed into the AMT
zone. Here are some key facts and situations related to the AMT:
Who should check for the AMT? If your income is above
$75,000 and you write off personal exemptions, state income
taxes, property taxes and home equity loan interest, it's best
to see if you're at risk. And if you're simply earning over
$100,000, you definitely should check for AMT eligibility no
matter what your deduction status. Form 6251 requires you to add
back some deductions and income exclusions to your regular
taxable income in the process of computing AMT. Among them: your
personal and dependent exemptions, or your standard deduction
if you don't itemize. You will also lose your state local and
foreign income and property tax write-offs and potentially your
home equity loan interest if you don't use your home equity line
for home improvements. Once computed, if the AMT is higher than
your regular tax liability you pay the additional amount (in
addition to regular taxes). The hit could be surprising.
Watch those stock options. If you're thinking of
exercising incentive stock options, keep an eye on the spread
between the market value at the time of exercise and the
exercise price. Although not immediately subject to regular tax,
the spread is subject to AMT. Based on advice particular to your
situation, you might want to keep those options still and not
exercise them until early 2008 to gain some tax flexibility.
If you own a business, get advice. If you own a
business, rental properties, or hold an interest in a partnership
or an S corporation, certain business depreciation deductions
might be a critical trigger for the AMT lens.
Tax-free bonds can be a trigger. The AMT counts as
income interest earned from municipal bonds designated as
private activity bonds, so there goes that tax edge. Many
tax-exempt money market funds and high-yield tax-exempt
municipal bond funds may hold relatively large percentages of
these bonds.
Know your AMT exemptions. For 2007, if Congress does
not extend the act increasing the exemption (the so-called AMT
"patch" legislation), the AMT exemption will be
decreased to $33,750 for an individual, $45,000 if married
filing jointly or if that person is a qualifying widow or
widower and $22,500 if married filing separately. These
exemptions were higher in 2006 after Congress came to the
rescue. As of this year, the exemption for Hurricane Katrina
victims is scheduled to expire as well as the additional
exemption for taxpayers who provide housing for a person
displaced by Hurricane Katrina.
More bad news. The following credits won't be allowed
against the AMT unless Congress rides to the rescue: child and
dependent care expenses, credit for the elderly or the disabled,
education credits, residential energy credits and the mortgage
interest credit. Also, if you live in the District of Columbia,
its first-time homebuyer credit will no longer be allowed
against the AMT.
The key is to work with your advisors to determine if you are
a likely target and include the AMT as part of the planning
process. Often, it is more something to be aware of than to be
avoided. Because the AMT is so complicated (and may complicate
financial decisions), the IRS provides an AMT Assistant for
Individuals — an electronic version of the AMT worksheet in the
1040 instructions — on the web
at http://www.irs.gov/businesses/small/article/0,,id=150703,00.html
November 2007 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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