Alternative Minimum Tax: Are You The Next Target?

Dec. 13 issue - The Alternative Minimum Tax is putting maximum pressure on taxpayers. Only 1.3 million people paid the tax in 2000. That figure has now jumped to roughly 3 million. By 2010, the Tax Policy Center estimates, some 30 million Americans—almost every household earning more than $100,000 a year—will be hit by the tax. So what's going on? Here, "The Ernst & Young Tax Guide 2005" explains everything you need to know about the AMT and how you can better prepare for it.

What is the AMT? It's a special tax that was introduced in 1969 to prevent rich Americans from claiming too many deductions and avoiding income tax altogether. It has its own unique rates—with fewer deductions than normal income tax and a less progressive scale. This is how it breaks down: the first $40,250 (or $58,000 for couples) of your income is exempt, although this exemption phases out at higher income levels. You're taxed 26 percent on the first $175,000 of the balance of your income, and 28 percent on anything you make above that. More people are now paying the tax because the AMT isn't indexed for inflation. The Bush tax cuts also made taxpayers vulnerable to the AMT because they reduced regular rates but not AMT ratesWho's most likely to feel the bite? Taxpayers who claim large deductions for any of the following: (1) state and local taxes—this includes income, real-estate and sales tax; (2) interest on home-equity loans not used for home improvement; (3) miscellaneous deductions like employee business expenses. Large families may also be subject, since personal-exemption deductions are not allowed for AMT purposes. There are a handful of other more esoteric circumstances, like Incentive Stock Options, that increase exposure—but most people probably don't need to worry about those. Finally, married filers with the same taxable income as single filers are more likely to be in the AMT because they're subject to lower ordinary income taxes.

So, what now? Without a fix from Washington, more and more families are going to get nailed in the years to come. Taxpayers in high-tax states, such as California and New York, are especially vulnerable. But many experts say a reprieve is all but inevitable over the next several years, because the huge number of people who will be trapped by the AMT will trigger new legislation to adjust the rates.

In the meantime, what's the game plan? If you make six figures in household income and take a lot of write-offs, there's a good chance the AMT is going to hunt you down and get you. A good strategy is to rethink traditional year-end planning and use it to your advantage. In other words, you should accelerate your income into 2004 and push deductible expenses into 2005. Then cross your fingers and hope that Congress comes up with a solution. For many taxpayers, a better alternative to the alternative minimum tax can't come soon enough.

Source: MSN