A Costly Alternative
What You Need to Know About the AMT

Doug and Ellen are what we think of as when we talk about the typical American couple.

They don’t think of themselves as wealthy, but they have good jobs: Ellen works for a large corporation, and Doug works for a small but thriving local company.

They purchased their first home, a modest three-bedroom colonial in a very nice neighborhood, a few years after they were married. But six years and three children later, they realized they needed to expand.

Doug and Ellen did their homework. They got quotes from multiple contractors. They checked references.

They even thought of a way to pay for the addition without touching their savings: They would execute the stock options that Ellen had received over the years from her company.

They drew up plans for every contingency. They were prepared for the delays. They were prepared for the additional costs. They were even prepared for temporarily moving out of the house during construction.

What they weren’t prepared for was a whopper of a tax bill the following April, thanks to those stock options and the Alternative Minimum Tax (AMT).

What Is the AMT?

A product of the Tax Reform Act of 1969, the AMT was designed to prevent the ultra-wealthy from using shelters to avoid paying income tax. It requires you to calculate your tax responsibilities under both regular and “alternative” rules (thus the name). If the tax calculated under the regular rules (say, $45,000) is higher than that calculated under the alternative rules (say, $40,000), you pay only the regular amount ($45,000). However, if the tax calculated under the regular rules is lower than that calculated under alternative rules (say, $50,000), you pay the difference between the two ($5,000), on top of your regular tax ($45,000).

Why Should I Worry?

Until relatively recently, middle-class Americans didn’t have to worry about the AMT. But while incomes— and regular income tax— have adjusted with inflation, the AMT has not. This means that the $150,000 incomes that the law was meant to target are now $1 million incomes. In other words, while you might see your $150,000 household as merely comfortable, chances are that the AMT sees you more like a rock star, professional athlete, or the chairman of General Motors.

On the surface, AMT tax rates are not much worse than regular tax rates. But the alternative rules allow far fewer deductions. For example, the following are excluded:

• the standard deduction,
• state, local, and property tax,
• unreimbursed business expenses,
• child-tax credits,
• tax-preparation and legal fees, and
• home-equity loan interest.

What’s more, the income exemptions that the AMT does allow are not inflation-adjusted. This means that the percentage of income exempted becomes smaller each year.

Finally, adding insult to all these injuries, if you are required to pay the AMT, you must file additional forms associated with the AMT, in addition to your regular tax forms.

How Do I Know If I’ll Be Hit With the AMT?

The only way to know for sure is to complete either the worksheets that accompany your 1040’s instructions, or IRS Form 6251 (Alternative Minimum Tax— Individuals). Still, there are a few common triggers. These include:

• Gross income of over $100,000,
• Numerous personal exemptions or itemized deductions,
• Medical expense deductions,
• A large state and/or local tax deduction,
• Owning a business, and
• A large capital gain (as Doug and Ellen discovered).

How Can I Avoid the AMT?

Having a six-figure income and living in a beautiful home in a nice neighborhood is, to many, the American dream. Unfortunately, high gross income and the state and property taxes that accompany most good neighborhoods are likely to expose you to the AMT. This will be the case until Congress updates the old law for modern finances.

To minimize the damage in the meantime, keep in mind that charitable deductions are allowed under the AMT, as is home mortgage interest as long as it’s not from a refinancing.

If you suspect you may be vulnerable to the AMT, by far the best thing to do is to see a tax professional. It could mean the difference between living the American dream and a financial nightmare.

Give us a call today at 1-800-450-0629 to find out how we can help.

Sources: IRS.