ALTERNATIVE MINIMUM TAX – AN INTRODUCTION
In the late 1960s, our tax laws were somewhat simpler and loopholes were abundant. Many higher income taxpayers, enabled by creative accountants, found legitimate ways to drastically reduce taxes all within the bounds of the tax codes.
To thwart the growing threat of diminishing tax revenue, Congress created the Alternative Minimum Tax. The AMT required higher income taxpayers to compute their regular tax first, then to recompute the tax under AMT rules. To compute AMT, one would start with regular taxable income, modify it with various adjustments and preference items (such as addbacks for property and income tax deductions and dependency exemptions), and subtract an exemption amount to arrive at alternative minimum taxable income (AMTI). Once done, tax rates of 26% or 28% were applied. Then the taxpayer would have to pay whichever tax was higher, the regular tax or the alternative minimum tax.
Fine idea at the time. It forced higher income taxpayers to lose some preferential deductions that only a wealthier taxpayer could afford, somewhat leveling the playing field between them and the ordinary taxpayer.
The problem now is that exemptions protecting the ordinary taxpayer from AMT haven’t kept up with inflation. Because so many “ordinary” taxpayers are being ensnared by AMT, tax revenues have climbed to the extent that it is now a significant source of tax revenue. In 2007, it is estimated that AMT alone will account for as much as $41 billion of tax revenue. This makes it difficult for Congress to abolish without raising taxes in other areas.
Are you subject to AMT? It is difficult to forecast individually without examining several detailed areas of your return. When we prepare your returns, we will advise you if you are subject to this tax.
Can you escape AMT? Not often. Timing of a few deductions is about the only tool that can be used, but often even that is not helpful. AMT is just a trap.
Here’s an example. A married couple filing jointly have gross income in 2007 of $170,000. They have two children and itemize their deductions. No capital gains, no unusual income items. They have paid state and local taxes of $20,389. Their personal exemptions total $13,600 ($3,400 per dependent).
REGULAR TAX COMPUTATION
| Total Family Income |
$170,000
|
| Less: Itemized Deductions |
-25,117
|
| Less: Personal Exemptions |
-13,600
|
| Taxable Income |
$131,283
|
| Federal Income Tax |
$25,752
|
ALTERNATIVE MINIMUM TAX COMPUTATION
| Taxable Income |
$131,283
|
Add Back:
+ State and Local Taxes
+ Personal Exemptions |
20,389
13,600
|
Deduct:
- Phaseout of Itemized Deductions
- AMT Exempted Amount |
-272
-62,500
|
| Total AMT Adjustments |
-28,783
|
| Alternative Minimum Tax Income (AMTI) |
$102,500
|
| x 26% = Alternative Minimum Tax |
$26,650
|
Since the AMT is higher, the tax will be:
| Regular Income Tax: |
$25,752
|
| AMT (Additional Tax) |
$898
|
| Total Tax (equals AMT) |
$26,650
|
In this case, the taxpayer paid $898 more in tax than would otherwise have been the case because of the incidence of AMT.
IRS collects billions from AMT. Killing AMT would mean losing the revenue source, and revising AMT means having to collect from other sources. This is the reason Congress hasn’t changed the laws and AMT will continue to be a challenge for all of us until someone finds better answers to the challenge.
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