The point of the alternative minimum tax is to insure that taxpayers with substantial income pay at least a reasonable amount of income tax. To accomplish that, Congress created what amounts to a separate tax system, lurking in the shadows and ready to spring into action if you benefit too much from tax breaks offered by the regular tax rules. Although this tax is much reviled during Congressional debate on tax policy, the lawmakers haven't been able to bring themselves to do anything about it. In fact, as matters now stand, millions of taxpayers who think of themselves as middle-class — not filthy rich — will be hit by the AMT within the next few years. For many, tax savings promised by the 2001, 2002, 2003 and 2004 tax cuts will be obliterated by this shadow tax.
Unfortunately, there's no easy answer to the question of who needs to be concerned about the alternative minimum tax.
A couple of things are certain. First, if you are subject to the AMT, your tax life is far more complicated. The interview for this issue will help you sort things out, but you still may want to seek professional tax help. This general discussion is aimed at helping you understand what's going on.
To know for sure whether you have anything to worry about, you (with this program's help) have to do your tax return twice: first applying the regular rules, then recalculating everything for the alternative minimum tax. You're required to file with whichever method produces the bigger bill.
Unlike the regular tax system—with five tax brackets ranging in 2006 from 10% to 35%; the AMT has just two rates: 26% for the first $175,000 of AMT taxable income; and 28% for income above that level.
So what's the big problem? Even at 28%, the AMT rate is seven percentage points lower than the top income tax rate. How can a lower rate produce a higher tax bill? That's the tricky part of the AMT: It applies to more income than the regular tax. Many of the deductions and other tax breaks that are perfectly proper for holding down regular taxable income aren't permitted under the AMT rules.
The first step toward determining whether you fall victim to the alternative minimum tax is to pinpoint your alternative minimum tax income (AMTI). The starting point is your regular taxable income. Not surprisingly, almost all the adjustments demanded by the alternative minimum tax increase that amount. The most likely to affect you: Personal exemptions. They aren't permitted to reduce alternative minimum tax income. Since they pulled down your regular taxable income, you must add back the amount of those reductions.
Many of the write-offs that reduce regular taxable income don't count for alternative minimum tax purposes. Add back deductions claimed for the following:
The alternative minimum tax has its own set of depreciation rules, which generally result in smaller write-offs than the deductions you get under the regular tax. To the extent that regular depreciation exceeds what you are allowed under the alternative minimum tax, you have another add-on to your alternative minimum tax income. It's possible, however, that the special depreciation rules will reduce alternative minimum tax income. That happens if you deserve a bigger write-off using the alternative minimum tax approach than you do by following the regular tax rules.
These rules promise to greatly complicate your recordkeeping. The different depreciation schedules mean your adjusted basis in the property (basically, that's cost minus depreciation) will be different for alternative minimum tax versus regular tax purposes. That, in turn, will affect your gain or loss when you sell. If you are subject to the alternative minimum tax, you'll have to keep separate sets of books tracing the tax basis of the property under each system.
Even Congress is embarrassed by the incredible complexity of this rule. As part of the 1997 tax overhaul, the lawmakers decided to eliminate this alternative AMT depreciation system, but only for property placed in service after 1998.
Here's an alternative minimum tax preference item that doesn't show up at all on the regular tax return. When you exercise an incentive stock option, you get to buy shares for less than current market value. The bargain element is ignored by the regular tax, but it is considered part of your alternative minimum tax income. Include in alternative minimum tax income the difference between what you paid for the shares and their market value when you exercised the option to buy.
In the year you sell the stock, however, you'll get to reduce alternative minimum tax income by the same amount. That's because your shares have a different basis for regular and alternative minimum tax purposes. Since you don't report the bargain element as income under the regular tax, your basis in the shares is what you pay for them. Under the alternative minimum tax, however, your basis is what you paid plus the amount you had to report as an alternative minimum tax preference item. The higher basis means you have a smaller taxable profit—for alternative minimum tax purposes—when you sell. The larger profit is included in regular taxable income; thus you subtract the difference when calculating alternative minimum tax income.
Tax-exempt interest on certain "private activity bonds'' issued after August 7, 1986, is a preference item to be added to alternative minimum tax income. Interest on such bonds, basically those issued by states or municipalities for nongovernmental purposes, is still tax-free under the regular tax. The issuer, or the broker trying to sell you the bonds, should be able to tell you whether interest is subject to AMT.
Although interest from these bonds remains tax-free for the vast majority of taxpayers, those who are not subject to the alternative minimum tax, the interest is taxed at the 26% or 28% AMT rate when earned by investors subject to the alternative minimum tax. This rule creates a potential benefit for some taxpayers. The alternative minimum tax threat pushes up the yield slightly on affected private-activity bonds, and that's a bonus for investors who don't have to worry about the alternative minimum tax.
Deductions for these can also be alternative minimum tax preference items for investors in oil and gas operations.
Once you arrive at your AMT income figure, you get to subtract an exemption amount based on your filing status: $62,550 if you are married filing jointly or a surviving spouse; $42,500 if you are single or a head of household; $31,275 if you're married filing a separate return.
The exemption is phased out, however, for taxpayers whose alternative minimum tax income exceeds certain levels. It begins to disappear when alternative minimum tax income is greater than $150,000 for taxpayers filing joint returns, $112,500 on individual returns, and $75,000 if you're married filing separately. For every $100 of excess income, the exemption shrinks by $25 until it is completely phased out.
After you subtract the exemption, you have arrived at the amount that is subjected to the alternative minimum tax rate. Apply 26% to the first $175,000 ($87,500 if married filing separately) and 28% to amounts over $175,000 ($87,500 if married filing separately).
There are additional calculations if your regular tax is partly due to long term capital gains or qualified dividends which are taxed at favorable rates in the regular tax and for AMT purposes.
Until 2001, the only tax credit permanently available for alternative minimum tax purposes was the foreign tax credit. When Congress created the child credit in 2001, however, the lawmakers decided to protect that credit from the AMT. So the child credit, the child care credit and the low-income savers credit all count. There's a lot of talk about "fixing" the AMT and the rules seem to be in a constant state of flux. You can count on TaxCut to make sure you pay the least possible tax -- whether or not you're subject to the AMT.