January, 2006 Tax Newsletter

Why Fear the Alternative Minimum Tax?

The alternative minimum tax (“AMT”) is a separate tax system that was originally created to ensure that high-income individuals, corporations, trusts, and estates would pay at least some minimum amount of tax, regardless of deductions, credits or exemptions.  It functions by adding certain tax-preference items back into adjusted gross income and disallowing or limiting several deductions. While it was once only important for a limited number of high-income individuals who made extensive use of tax shelters and deductions, more and more middle income people are now being affected by it. 

The AMT is often triggered when there are large numbers of personal exemptions, state and local taxes, miscellaneous itemized deductions or medical expenses, or by Incentive Stock Option plans.  Another reason it can occur is that ordinary income tax brackets and personal exemption amounts are adjusted annually for inflation, but AMT brackets are not.  As a result, as income levels rise, tax liabilities under the AMT calculation rise proportionately.

When working on year-end tax plans for my clients this past month, I found that several of them fell into the AMT.  A few felt that this was the end of the world.  Let me say that, while it may be possible to take certain steps to plan around or minimize the effect of the AMT, it just may be that it can’t be avoided.  If this is the case, a good tax practitioner will look for opportunities to make the AMT an ally instead of a foe.  As more taxpayers become liable for the AMT tax planners’ objectives should be not so much to avoid the AMT, but to recognize how it can influence other planning strategies.  For example, tax practitioners typically tell their clients to defer income and accelerate deductions.  But if a client is affected by the AMT, the opposite advice may be appropriate.

The President’s Advisory Panel on Federal Tax Reform has recently proposed repealing the AMT.  However, the real world is that the vast revenues generated by the AMT are critical to the Treasury.  Thus, the government has a strong economic incentive to keep the AMT, albeit perhaps in a bit of a watered-down form.

You should be aware throughout the year of your potential AMT exposure.  The more planning time that is available the better your chances of avoiding or minimizing its impact on your tax situation.  The best recommendation I can offer is to do periodic calculations during the year. 

As always, I would be happy to work with you to keep the AMT wolf from your door.