According to the Tax Policy Center, about 2.4 million taxpayers will pay the Alternative Minimum Tax or AMT this year. An alternative set of rules for calculating your income tax, the AMT was designed to prevent people with high incomes from using special tax benefits to pay little or no tax. Since there has been no adjustment for inflation, increasingly more middle-income filers must pay it.
Tax attorney Donna LeValley, a contributing editor to J.K. Lasser's Your Income Tax 2004, (ISBN: 0471466557 John Wiley & Sons, Inc.), offers these tips to taxpayers who may unwittingly get caught in the AMT trap.
You can have AMT liability because of one big item on your tax return, or because of a combination of many small items. Some things that can contribute to AMT liability are very mundane items that appear on many tax returns, such as a deduction for state income tax or interest on a second mortgage, or even your personal and dependency exemptions. Various tax benefits that are available under the regular tax are reduced or eliminated.
You get a special deduction called the AMT exemption, which is designed to prevent the AMT from applying to taxpayers with modest income.
Here are some of the types of things that can trigger the AMT:
These items must be added back to your taxable income in order to compute your AMT:
1. All personal exemptions Believe it or not, exemptions contribute to AMT liability. The exemptions you claim for yourself, your spouse and your dependents are not allowed when calculating alternative minimum tax. It's pretty rare (though not impossible) to see a tax return where someone had to pay AMT solely because of their exemptions, but the more exemptions you claim, the more likely it is that you'll have AMT liability when all is said and done.
2. The standard deduction, if you claimed it. Some 70 percent of American taxpayers claim the standard deduction (rather than itemizing). The standard deduction isn't allowed under the AMT. Usually this isn't a problem because the AMT generally hits people with higher incomes, and these people are more likely to claim itemized deductions. Yet it's worth noting that a deduction that's so widely used can contribute to AMT liability.
3. Itemized deductions for state and local income taxes, and real estate taxes. If you itemize, there's a good chance you claim a deduction for state and local tax, including property tax and state income tax. These deductions are not allowed under the AMT. If you live in a place where state and local taxes are high, you're more likely to be subject to the alternative minimum tax.
4. Itemized deductions for home equity loan interest (this does not include interest on a loan to buy, build, or improve your home). The AMT allows a deduction for interest on mortgage borrowings used to buy, build or improve your home. If you borrowed against your home for some other purpose, the interest deduction isn't allowed under the alternative minimum tax.
5. Itemized deductions for miscellaneous deductions. The AMT allows a medical expense deduction, but it's more limited than the deduction under the regular income tax. If you claim an itemized deduction for medical expenses, part or all of it will be disallowed when you calculate your alternative minimum tax.
6. Itemized deductions for any portion of medical expenses that exceed 7.5 percent of AGI but not 10 percent of AGI. Certain itemized deductions are available if your total in this general category is more than two percent of your adjusted gross income. Among the items here are unreimbursed employee expenses, tax preparation fees, and many investment expenses. You can't deduct these items under the AMT, though. If you claim a large number in this area, you could end up paying alternative minimum tax.
7. Addition of certain income from incentive stock options. Generally you don't report anything on your regular income tax at the time you exercise an incentive stock option. But you have to report income for purposes of the AMT. Exercising a large incentive stock option is almost certain to cause you to pay alternative minimum tax.
If you have large amounts of any items in this list, and your adjusted gross income exceeds the exemption amounts you (or your accountant) should compute your AMT liability on IRS Form 6251, Alternative Minimum Tax - Individuals, to determine whether you must actually pay any AMT. For 2003 and 2004, the exemption amounts are $58,000 for marrieds filing jointly and surviving spouses; $40,250 for singles and heads of households; and $29,000 for marrieds filing separately. If your taxable income for AMT purposes (called AMTI) exceeds the exemption amount, you will be subject to a 26 percent AMT rate on the first $175,000 of AMTI that exceeds the exemption amount, and a 28 percent rate on any AMTI above this $175,000 amount.
If your AMT liability and your regular tax liability tend to be approximately equal from year to year, your best bet is to maintain this stability. If your deductions are not so evenly spaced and you tend to have great fluctuations in income from year to year, you may be able to shift some AMT-triggering items from an AMT year to a non-AMT year, so as to reduce your liability in a non-AMT year almost to the point at which you would become subject to the AMT.
