Five Ways to Take the Bite Out of Alternative Minimum Tax (AMT)

AMT Was Intended for the Wealthy, But Unsuspecting Middle Class Taxpayers Today Are Likely to Face Unpleasant AMT Calculations

In the past, mostly high-income folks who overindulged in various tax breaks were the ones that came face-to-face with the dreaded individual alternative minimum tax (AMT), "This is no longer the situation; AMT can grab anyone," says Robin Christian, PPC Senior Tax Analyst from Thomson Tax & Accounting.

There are still Americans who say "What is this?" when AMT becomes part of their return. AMT runs parallel to the regular tax. First, you calculate your regular income tax based on regular taxable income. Next, you add back certain deductions and "preference items" to your regular taxable income to calculate AMT. Ultimately, you pay the higher of the two taxes.

"This wouldn`t happen as often as it does currently and it can be attributed to the AMT exemption and tax rates lacking inflation adjustment mechanisms applicable to many regular tax rates, deductions, and exemptions," says Christian. "Also, thanks to a number of taxpayer-friendly tax acts over the last few years, regular tax rates for many of these middle income tax-payers are about the same as AMT rates. For 2007, married couples filing jointly are in the 28% regular tax bracket until taxable income goes above $195,850 and the 33% regular tax bracket until taxable income goes over $349,700. Compare that to the AMT rate of 26% on alternative minimum taxable income up to $175,000 and 28% above that amount, and it`s easy to see the root of the problem."

Currently, unsuspecting "ordinary Joe" taxpayers with several kids and high state income or property tax bills are the most likely AMT victims. Throw in a large capital gain or the exercise of a few incentive stock options and there`s no escaping it.

"It`s plain to see that AMT is now actually more likely to burn middle-income types than the truly wealthy," says Christian.

Says Christian, "When AMT strikes, you lose the benefit of many traditional tax breaks, including personal exemptions; state and local income, property, and sales tax deductions; home equity loan interest expense deduction (unless the loan proceeds were used for home improvements); and, for those who don`t itemize, the standard deduction -- and that`s just to name a few."

Do`s and Don`ts for AMT Planning. Unfortunately, it`s often difficult to "plan around" the AMT. Tax laws were cleverly drafted to prevent moves that are effective in reducing regular income taxes from also reducing AMT liability. This means that many traditional planning strategies don`t work for AMT; in fact, many may backfire. But there are a few "dos and don`ts" PPC offers to taxpayers, which can lessen the effect of the AMT:

  1. Do take action to reduce your adjusted gross income (AGI) for 2007. A
     lower AGI makes it more likely you`ll be able to claim your full AMT
     exemption, or at least a bigger part of it. A lower AGI will also
     reduce your state and local income tax bills, which will further reduce
     your AMT exposure. Finally, a lower AGI may also qualify you for any
     number of other breaks that will reduce both the regular tax and AMT
     liabilities. How can you reduce your AGI?   The most common techniques
     are using income or deductions that you can easily control. For
     example, cash-basis sole proprietors and farmers might delay year-end
     billings so that they fall in the following year and/or accelerate
     payment of certain expenses, such as office supplies and repairs and
     maintenance to 2007. On the investment side, income from short-term
     (i.e., maturity of one year or less) obligations like Treasury Bills
     and short-term CDs is not recognized until maturity. Income from those
     straddling year-end is deferred to the following year. For sales of
     property, consider an installment sale that shifts part of the gain to
     later years when the installment payments are received.  You could
     unload a bad investment or two before year-end, thereby triggering
     deductible capital losses of up to $3,000 for 2007.

"In short, there are many proactive moves you can make -- what works for you will depend on your individual tax and financial situation. This is one area where competent tax advice can be instrumental," says Christian.

  2. Don`t prepay state and local income or property taxes that would
     otherwise be due and deductible in 2008. Prepayment may generate a
     bigger regular tax write-off for 2007, but the deduction is completely
     disallowed in computing AMT. So, prepaying in 2007 could turn an
     expense that could otherwise be deducted in 2008 into an expense that
     will never generate any tax benefit whatsoever.

  3. Do pay your January 2008 home mortgage payment and any planned 2008
     charitable donations in 2007 instead of waiting until 2008.  These
     items are deductible for both AMT and regular tax, so paying them in
     2007 will cut your 2007 AMT tax bill. This is true even if your
     itemized deductions don`t exceed your standard deduction for 2007.
     However, since you are using the same method to calculate regular tax
     and AMT, it is imperative that you elect to itemize deductions by
     completing Schedule A when you file your Form 1040. Also, prepayment
     will work for interest on home equity loans only if the loan proceeds
     were used to buy, build, or substantially improve your home --
     otherwise the interest is not deductible for AMT.

  4. Don`t buy tax-free municipal bonds that fall into the private activity
     bond category (such as bonds issued to finance sports facilities).
     Interest on these bonds is tax-free under the regular tax system, but
     is taxable under AMT.

  5. Do think twice before using home equity loan proceeds to pay off debts
     that generate nondeductible personal interest (for example, to pay off
     credit card balances). Interest on such loans is deductible for regular
     taxes, but not for AMT. Of course, you may still come out ahead
     economically by taking out a low-interest home equity loan to pay off
     high-interest debts. There just won`t be any tax savings. Also,
     interest on home equity loans used to buy, build, or substantially
     improve your home is deductible for both AMT and regular taxes.

Christian urges taxpayers who have a remote chance of encountering AMT to take a fresh look at their tax planning options, now rather than later. Some well planned maneuvers before year end can go a long way in taking the bite out of AMT come April 15.

The Thomson Corporation

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Source: Thomson Tax & Accounting

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