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You've heard of the Alternative Minimum Tax (AMT), but have probably paid no attention to it. After all, isn't that the tax that was intended to make sure that the wealthy would pay their fair share in taxes? Not any more. Middle class families with incomes as low as $75,000 are starting to be subject to the Alternative Minimum Tax.
In fact, the odds are high — and getting higher each year — that you may also be subject to this complex "shadow" tax that could pretty much nullify your current tax deductions and credits, and subject you to federal taxes calculated under a whole different set of rules.
Alternative Minimum Tax Basics
The Alternative Minimum Tax was enacted in 1969 to catch high–income earners who paid little if any tax. Today, the AMT is primarily penalizing middle class taxpayers by eliminating their deductions and credits. You could be at greatest risk if you are married, have children and/or itemized deductions, including those from state taxes.("The Alternative Minimum Tax," Smartmoney.com (undated, copyright 2004). Web page: (www.smartmoney.com/tax/filing/index.cfm?story=amt)
The Alternative Minimum Tax is a separate, "parallel" tax system with its own set of rules and tax rates that are less generous than the regular tax system. If you are required to pay the AMT tax, the rate is 26% for the first $175,000 of alternative minimum taxable income, and 28% on anything over that.
Now for the scary part. The income limits were not indexed for inflation. As a result, while the Alternative Minimum Tax was paid by only 19,000 filers in 1970, it affected nearly 2.6 million in 2002. By 2010, it is projected that the Alternative Minimum Tax will apply to 33 million taxpayers, about 1/3 of all returns. This includes 93 percent of all households with incomes between $100,000 and $500,000; 73 percent of households with incomes between $75,000 and $100,000; and 37 percent of households earning $50,000 to $75,000.("Key Points on the Alternative Minimum Tax," The Brookings Institution, 1/21/04. Web page: www.brook.edu/views/op-ed/gale/20040121amt.htm)
Worst of all, the Alternative Minimum Tax is extremely complex, and the only way you can tell if you are subject to the AMT is to calculate your taxes both ways. If the AMT calculation comes out higher, that is the amount you owe.
You May Be Subject to AMT if...
- Your household income exceeds $75,000 and you have deductions for personal exemptions, state and local taxes and home equity loan interest;
- You exercised incentive stock options during the tax year;
- Regardless of income, you own a business, rental properties, a partnership interest, or S Corporation stock;
- You earned more than $100,000.
Overview of Add—backs and Exclusions
If you suspect you may be subject to the Alternative Minimum Tax, you should complete Form 6251. This form adds back the following deductions and exclusions into your taxable income:
- Add back into your income your personal and dependent exemption deductions ($3,500 each in 2008).
- Next, add back your standard deductions if you don't itemize ($10,900 for joint filers in 2008).
- Add back state and local taxes.
- Add back home equity loan interest if the loan was not used for home improvements.
- Add back miscellaneous itemized deductions and some medical and dental expenses.
- Add in the "spread" between market price and the exercise price of incentive stock options from your employer. (Example: If you bought at $6 and it traded at $10, you pay tax on the $4 difference.)
In other words, after you take all your deductions to which you are legally entitled, you must then add them back in again.
A Few Bright Spots
It's not all bad news. If you fall under the AMT rules, you do get a few breaks. Among them:
- You can deduct tax refunds, unlike with your regular tax.
- If you are taxed on the exercise of incentive stock options, your basis for AMT purposes is higher when you sell the stock.
- Under current law, you get to deduct the exemption of $45,000 (for joint filers and $33,750 for unmarried couples) in 2008. However, this exemption is reduced by 25 cents for each dollar of Alternative Minimum Taxable Income above $150,000 for couples ($112,500 for singles).
- You could be eligible for a minimum tax credit, which gives you a credit in future years for some of the extra taxes you pay under the Alternative Minimum Tax rules.
What to Do
The Alternative Minimum Tax rules are complex and confusing. We've given you a basic overview. This having been said, be aware that it is increasingly likely that you may be liable for the Alternative Minimum Tax, even if your household income is fairly modest.
Unfortunately, if your income is $75,000 or higher, the only way to tell if you owe the AMT is to calculate your taxes both ways, so you need to automatically complete Form 6251, which can be demanding, time consuming and complicated.
There is a good chance the AMT rules may undergo reform in the coming years. In the meantime, if you suspect you may be subject to the Alternative Minimum Tax, consider consulting with a qualified accountant, one who understands the finer points of this deduction–erasing tax.
Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice.
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