AMT, The Unintended Tax

Fall, 2008

The tax that was intended for the wealthy, now affects the middle-income and upper –middle-income taxpayers.  In 1969, Congress came up with AMT, alternative minimum tax, as a way to prevent the wealthy from using tax loopholes to avoid paying income tax.  At the time it probably was not a bad idea but as income levels continue to rise, AMT now affects more and more taxpayers.  Currently over 2 million taxpayers pay AMT tax and within 7 years it is expected to affect over 31 million taxpayers.

Once you have prepared your tax returns in the traditional manner, you must also prepare Form 6251 (Alternative Minimum Tax – Individuals) and compare the two results.  Guess what, you will pay the higher of the two. 

Why does this tax now affect millions?  Because unlike many items in the income tax code, which are indexed for inflation, AMT is not indexed.  Also, as tax cuts from the 2001 and 2003 tax laws have reduced the marginal tax rates, the AMT rates have remained the same.  Also, many taxpayers are coupled with higher itemized deductions.

• For those who itemize, AMT does not allow deductions for state and local taxes, property taxes (including real estate), medical expenses and miscellaneous itemized deductions.  It only allows mortgage interest and contributions.

• AMT also doesn’t allow personal exemptions plus there are many items, which must be added to adjusted gross income to arrive at AMT taxable income.

• Items that are taxed at lower tax rates such as dividends and capital gains, will affect the AMT calculation.  Dividends and capital gains are now taxed at 15% while the AMT tax rates are 26% and 28%.

• Depreciation must be recalculated under AMT because of different depreciation methods and lives allowed.

• Exercising incentive stock options will almost always put the taxpayer into AMT.  The difference between the market price of the stock at the time of exercise and the amount paid for the stock is an AMT item even though taxpayer has not sold the stock.  Thus, the taxpayer ends up paying tax on stock they have not sold.  For example, let’s assume the market price of the stock is $100 and the option price is $10.  Let’s further assume that taxpayer exercise 1000 shares and pays $10,000 to purchase the stock, which is worth $100,000.  The difference between the market value of $100,000 and the cost of $10,000 or $90,000 is added as an AMT item thus causing taxpayer to pay tax on phantom income.

Calculating AMT is not easy because of the various items involved.  Even tax professionals rely heavily on sophisticated software to assist in the calculations.

Don’t be surprised if sometime in the near future you are subject to AMT.  If you have any questions about AMT or if you feel you might need help in this area, give us a call.