Alternative Minimum Tax (AMT) was originally created to ensure that all taxpayers pay their fair share of tax. It was intended primarily to affect high-income earners who were using tax shelters and other deductions to reduce their tax liabilities. However, in recent years, an increasing number of middle-class taxpayers have been assessed AMT. An estimated 3 million taxpayers will be subjected to AMT in 2004 with projections growing to approximately 30 million in 2010.
What is it?
To calculate AMT, compute taxable income under the regular income tax method. From that figure, add back various deductions which were utilized in arriving at regular taxable income. Common add backs include state and local income taxes, real estate taxes, miscellaneous itemized deductions and personal exemptions. After adding these deductions, the taxable income amount for AMT purposes will be greater than regular taxable income. After an adjustment for an annual exemption, the amount is then multiplied by a tax rate of 26% or 28%. If the result is greater than your regular income tax, the difference is the additional tax which is classified as AMT. For example, if the regular tax is $20,000 and the alternative minimum tax is $25,000, the taxpayer would owe $25,000 ($20,000 of regular tax and an additional $5,000 of AMT).
What causes it?
There are several underlying issues that have caused AMT to affect more taxpayers. There have been two large tax cuts in the last three years which have decreased the calculated tax under the regular method without a corresponding decrease in AMT. Additionally, Congress has been reluctant to index AMT to inflation, enabling it to creep into more returns.
How to minimize its effect
If your tax situation produces an AMT liability, it can be difficult to avoid the tax. However, timing your deductions can minimize your exposure. For example, the popular tax reduction strategy of prepaying your fourth quarter state estimated tax payment by December 31 should be reviewed to determine if any benefit is being realized. Also, taxpayers in states with high income taxes and who have substantial mortgage and property tax deductions are likely to be hit with AMT.
The House of Representatives recently approved the increase of the exemption amounts for AMT in the Jobs and Growth Tax Relief Reconciliation Act of 2004. The bill will proceed to the Senate for approval. Congress appears to lack the political will to tackle the AMT problem this election year, so don't expect its much-needed overhaul or repeal