Are You in Deep with the AMT?

Beverly and her husband, John, do all right, but they’ve never considered themselves “wealthy.” That’s why Beverly was quite perturbed to learn that more and more middle-class taxpayers are being subjected to the costly alternative minimum tax (AMT), which was designed to ensure that the most well-to-do Americans don’t escape their tax obligations by exploiting certain tax breaks. She visited her financial advisor to find out how deep she was in with this tax.

The advisor explained that the AMT is essentially a parallel tax system with its own rates, deductions and exclusions. You pay either the regular tax or the AMT, whichever is higher. Unfortunately, more and more middle-class taxpayers have recently fallen into the AMT’s grasp. In fact, 63% of taxpayers with incomes between $100,000 and $200,000 will owe it next year, says the Tax Policy Center.

Testing the waters

To determine whether the AMT would snag Beverly , her advisor had to crunch some numbers. Specifically, he followed three steps:

1. He calculated her alternative minimum taxable income (AMTI). This number is derived by taking regular taxable income and adding back preference items, such as personal exemptions; deductions for state and local income or sales taxes, real estate taxes, and personal property taxes; some deductible medical expenses; and certain investment interest expenses.

2. Next, he subtracted her AMT exemption amount — $58,000 for joint filers ($40,250 for singles). This exemption is reduced by 25% of the amount by which AMTI exceeds $150,000 for joint filers ($112,500 for singles). Absent new legislation, next year’s exemptions will return to the previous levels of $49,000 and $35,750, respectively.

3. Last, he multiplied the amount calculated in Step 2 by the AMT tax rate — 26% of the first $175,000 of income and 28% on the excess. This tax is then compared to the regular federal income tax.

Decades ago, the AMT exemption did a good job of shielding middle-class taxpayers from liability. But since then, the regular tax rates have been reduced, while AMT rates have remained the same. So as middle-class incomes grow, more taxpayers are finding that their AMT liability exceeds their regular income tax liability, and thus they have to pay the AMT.

Staying afloat

Looking at the numbers, Beverly ’s advisor did note some significant amounts of one or more preference items. To avoid or minimize the AMT, he suggested she consider deferring expenses that aren’t deductible for AMT purposes, such as state taxes. She could also put off recognizing large capital gains or other income to avoid the AMT exemption phaseout.

There are bolder moves Beverly could look into as well. If she and her husband could increase their regular taxable income, the AMT might no longer be an issue. They might also pay off any home equity loans that they didn’t use to buy, build or substantially improve their residence, because interest expense on these loans is added back for AMT purposes.

Their advisor warns Beverly that these strategies may increase her AMT liability next year when the exemptions will be lower, so she may be better off biting the bullet and paying the tax this year. If the items causing the AMT will recur year after year, there may be little she can do about it.

Riding the rough seas

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