October, 2008

The Confusing, Confounded and Cursed AMT

Every year more and more taxpayers get notified by the IRS that they either failed to include the alternative minimum tax (AMT) on their returns or miscalculated the amount of the tax.  In some of these cases (including one of my clients) the error was that of the IRS.

The AMT is perhaps the most controversial area of the tax law.  It appears that Congress doesn’t want it but, due to the amount of revenue it raises, it doesn’t want to get rid of it.  It was originally intended to ensure that a small number of high-income taxpayers would pay at least some tax despite the provisions in the tax laws that greatly benefited them.  Many taxpayers are still of the belief that the AMT will not apply to them because of its original intention to hit the rich.  Unfortunately, the tax’s application has expanded dramatically and now is hitting many middle income taxpayers, much to their chagrin.

As it has done in the past few years, Congress is expected to be approving a one-year “patch” designed to prevent many potential AMT victims from getting caught in the trap for their 2008 returns (in fact, as I write this, the House has just approved a patch).  Essentially, what the patch does is retain the higher amounts of AMT income that are exempted from the AMT, rather than revert to the lower exemption amounts that are set forth in the tax laws.  Obviously, these patches are annual band aids that keep masking the real problem.  Unfortunately, no one knows what Congress will ultimately come up with as a more permanent cure.

The AMT and the regular tax are calculated under very different rules.   Taxpayers pay the higher of the two calculations.  The AMT has different items included in its income base and different allowable deductions and credits.  For example, such popular deductions as taxes and miscellaneous itemized deductions are not allowed in the AMT calculation, and medical expenses are subjected to a higher limitation.  Also, exemptions for the taxpayer and dependents are not allowed.  Those most likely to be affected by the AMT are larger families living in high state tax areas, such as New York and California, and whose income ranges between $100,000 and $500,000.   However, I have seen cases of the AMT applying to taxpayers with incomes substantially lower than $100,000.

There are planning strategies and opportunities to minimize, if not eliminate, the AMT but, in virtually all cases, they must be implemented prior to year end.   If you sense that you may be an AMT candidate, I highly recommend that you consult with a tax professional.