ABCs of AMT

By Phillip E. Goldstein, Managing Partner Goldstein Lieberman & Company LLC

Business Advisers and Certified Public Accountants

Think the Alternative Minimum Tax rules don’t apply to you? Think again! While Congress originally devised the alternative minimum tax (AMT) rules to ensure that high-income individuals who take advantage of multiple tax breaks will still owe taxes each year, today even upper-middle-income taxpayers are likely to be affected.

The AMT is a tax system that works in parallel with the regular federal income tax system—while some taxpayers use the regular system, others must use the AMT system. The AMT has its own set of forms, rates, rules, and brackets, and requires taxpayers to calculate their federal income tax using this system.

Unlike the regular income tax, however, the AMT is not indexed for inflation. Over time, inflation makes more and more middle-income taxpayers to be subject to the AMT. Certain types of income that are tax-free under the regular federal income tax system are taxable. The AMT rules also disallow certain deductions and credits that are allowed under the regular federal income tax system.

On the other hand, the maximum AMT rate is only 28% compared to the 39.6% maximum rate that applies under the regular federal income tax system. In addition, taxpayers are allowed a relatively large inflation-adjusted AMT exemption, which is deducted when you calculate AMT income. Unfortunately, the exemption is phased out when your AMT income surpasses certain levels.

If your AMT liability exceeds your regular federal income tax liability for the tax year, you must pay the higher AMT amount. Taxpayers are generally more at risk if they have: substantial (but not necessarily huge) salary income (more than $250,000 per year); significant long-term capital gains and/or dividends; large deductions for state and local income and property taxes; a spouse and several children (e.g., at least four) who provide personal and dependent exemption deductions for regular federal income tax purposes. And more. Make sure you know your risk.

What to do?

Reducing your adjusted gross income (AGI) might help to reduce or avoid the AMT because by lowering AGI you will also slash your state and local income taxes, which are disallowed for AMT purposes and, therefore, decrease your AMT exposure. Likewise, if you’re likely to be hit with the AMT, the traditional tax year-end strategy of prepaying state and local income and property taxes that are due early next year won’t help you. Those taxes aren’t deductible under the AMT rules. So prepay them in a year when you have a chance of not being in the AMT mode.

Don’t automatically assume you’re exempt from the AMT. If you’re in a higher tax bracket, you probably have some risk factors. The IRS is on the lookout for unsuspecting folks who owe the AMT. You could owe back taxes, interest and potential penalties under the AMT rules.

Consult with your tax adviser. Know whether you’re at risk and help find ways to reduce your exposure to the AMT.