Every time we hear about a tax cutby the government, we welcomethe chance to pay less to the IRS.However, there may be a downside tothese reductions in our tax bill. Onepotential pitfall is the alternative minimumtax (AMT). Because of tax cuts, suchas the ones in 2001 and 2003, more taxpayersnow face the possibility of havingto pay the AMT.
Washington enacted the AMT in 1969to address the problem of extremelywealthy individuals using various credits,deductions, and other tax breaks to reduceor eliminate their income tax liabilities.The AMT calculation is designed to ensurethese individuals pay at least some tax.
While it seems appropriate that we allpay our fair share of taxes, there are acouple of troublesome issues with theAMT. First, the calculations for figuringthe AMT are complex, making it difficultto anticipate when you are setting yourselfup to pay the tax. Second, the taxrates and exemptions for the regularincome tax, figured on your 1040, areindexed for inflation, but those for theAMT are not, causing more and morepeople to pay it.
In addition, an AMT exemption wasdesigned to protect most average incometaxpayers from the tax. However,as salaries have risen through the years,this exemption is losing its effectivenessand, as a result, each year more middle-classAmericans must pay the AMT. Infact, the Tax Policy Center predicts thatby 2010, the AMT could catch 37% oftaxpayers with adjusted gross incomes of$50,000 to $75,000 and about 73% ofthose with adjusted gross incomes between$75,000 and $100,000.
Because the rules are so complex,explaining the intricacies of the AMT isbeyond the scope of this article, so consultwith your tax advisor. However, there areseveral points you should understand.
First, the AMT calculation is separatefrom your regular income tax calculation.If you think your situation may trigger theAMT, you'll need to complete IRS form6251 with the help of your tax advisor.Basically, when the tax you calculate onyour Form 1040 is greater than what youcalculate on your Form 6251, you pay theamount from your Form 1040 (your regularincome tax). However, when theamount you calculate on Form 6251 isgreater than what you arrive at on yourForm 1040, you must pay the amount fromthe Form 1040 plus the AMT, which is thedifference between the two calculations.
Here's where the problem created bytax cuts comes in. Ironically, because thecuts reduced the amount individuals calculateon their 1040, they've increasedthe possibility that the amount a taxpayercalculates on their 1040 will be smallerthan their AMT calculation, whichmeans more taxpayers are likely to besubject to the AMT.
Your chances of paying the AMT increaseif you have several children, interestdeductions from second mortgages, interestfrom private activity bonds, large capitalgains, or high state and local taxes. Exercisingincentive stock options may also contributeto the chance you'll owe the AMT.
is vice president,
investments, and a financial
consultant with AG Edwards in
Hillsborough, NJ. He welcomes
questions or comments at 800-288-0901 or www.agedwards.com/fc/joseph.lagowski. This article was provided
by AG Edwards & Sons, Inc, member SIPC.
Joseph F. Lagowski