Alternative Minimum Tax Discussion

What type of tax was originally designed to deter wealthy taxpayers from avoiding tax and by the year 2010 could affect approximately 30 million U.S. taxpayers?

If you said the Alternative Minimum Tax (or AMT) you would be correct. 

AMT was created in 1970 because some high income households were paying little or no tax at all.  AMT is paid in addition to your regular income tax.  It is calculated by taking the taxable income from page two of your personal income tax return and adding back certain items which the IRS feels could be giving you an unfair tax advantage.  The following are the most common items added back:

4    Personal exemptions – based on the number of dependents claimed on your personal return

4    Medical expenses – there are already limitations on this, but AMT imposes even more

4    Interest on second mortgages – if the proceeds were not used to buy, build or improve your home (such those used to purchase a car)

4    Standard deduction – if you use the standard deduction as opposed to itemizing

4    All taxes, including state and local income tax, sales tax and real estate tax

4    Miscellaneous itemized deductions – such as tax preparation fees, unreimbursed employee expenses and investment expenses

4    Incentive stock options – generally the difference between the FMV and the price paid for the stock

4    Tax exempt interest from specified private activity bonds

4    Various credits – allowed for regular tax purposes but not allowed for AMT purposes

4    Other less common items for AMT are listed on IRS Form 6251.

Due to the lowering of the regular tax rates in recent years, many more taxpayers are finding themselves subject to AMT.  High amounts of ordinary income (wages, Schedule C income, income from pass through entities) may place you in the position of avoiding the AMT in a given year.  Large amounts of long-term capital gains and qualified dividends (both currently taxed at the special 15% rate) may cause AMT to apply.  Keep in mind that most mortgage interest and all charitable contributions are still fully deductible for purposes of the AMT.  

One way to diminish or greatly reduce AMT is by tax planning.  This would involve running tax projections prior to the close of the current year and for subsequent years.  One common tax planning technique would involve delaying or prepaying state and local income taxes or real estate taxes.  In addition, notify your tax adviser before exercising stock options or before taking large long term capital gains.  Tax planning may help lessen the burden; unfortunately, in some cases, alternative minimum tax is unavoidable.