The Impending Alternative Minimum Tax Nightmare

Most of us would have stood up and applauded the government when they created the Alternative Minimum Tax (AMT) in 1969. Originally, the AMT was established to prevent the wealthiest taxpayers from taking enormous deductions to reduce their taxable income. Unfortunately, recent changes to the tax code will have the unintended results of ensnaring millions of unsuspecting middle and upper-middle class families.

Coexisting with the traditional income tax system, the AMT is essentially a flat tax. It has earned the nickname of the “stealth tax” as many taxpayers are unaware of its existence until they must pay it. For those of you who are unfamiliar with the AMT, it is useful to examine how it works.

Put simply, the IRS requires two tax calculations: your normal tax liability and your AMT liability. AMT starts with your original taxable income and then adds certain “preference” items that normally have favorable tax treatment under the traditional system. After an exemption amount, the tax is levied at up to 28% to arrive at your AMT liability. If the AMT liability is higher than the regular tax liability, you must pay the higher amount. For most of you, the AMT liability has always been lower than your regular liability. Things are about to change!

To help target the right taxpayers to pay AMT, the federal government uses an exemption amount to reduce the AMT liability. That exemption amount generally keeps the AMT lower than the normal tax for most taxpayers. In 2006, the exemption amount for married taxpayers filing joint returns was $62,550. The exemption is reduced to $45,000 for 2007 and the foreseeable future. For millions of taxpayers, this change will single-handedly result in paying AMT for the first time. For those who are already subject to AMT, the instantaneous result is an added $4,900 or so in taxes due.

Families who own homes and have children are vulnerable to AMT exposure. For many taxpayers, most tax deductions and exemptions are from items such as personal exemptions for children, deductions for property tax paid, interest on home-equity loans not used for home improvements, just to name a few. Taxpayers must add these items back to their income for AMT calculation purposes. Also, anyone who has or will have employee incentive stock options should contact a financial professional before executing those options.

When planning for taxes, it pays to act sooner rather than later. Even with a professionally planned strategy, a wise taxpayer, regardless of their socio-economic status, should prepare to pay more tax in April of 2008.