The alternative minimum tax (AMT), which was meant to sting the rich, now affects taxpayers with incomes as low as $75,000. Under current law, about one million taxpayers are subject to the AMT, but that number is projected to increase to nearly 15 million in 2010, according to the Joint Committee on Taxation.
The AMT is a parallel tax system that presents taxpayers with a lose-lose dilemma. Under the AMT, some tax deductions and tax credits are added back to your regular taxable income. Thus, you have a greater amount of “AMT income,” which is then taxed at a 26 percent or a 28 percent rate. You pay whichever tax bill is higher, the regular tax or the AMT.
Suppose you prepare your federal income tax return and come up with an obligation of $40,000. Then you go through the AMT calculation and see that you’d owe $35,000, by that method. You’d pay the $40,000 regular tax.
On the other hand, if you have a $50,000 regular tax obligation and a $60,000 AMT you’d pay the $60,000 AMT bill: the IRS always wins in this game.
You are most likely to run into to the AMT if you live in an area where you pay large amounts of state and local income tax as well as property tax in relation to your income. Sizable miscellaneous itemized deductions also may put you into the AMT and so can large amounts of capital gains.
Some planning tactics may help you to contend with the AMT. Talk to your tax preparer regularly about your finances so you can drop your tax bill to (but not below) the AMT “crossover point.”
Year-end pre-payments. Suppose you’re in the habit of prepaying state and local income taxes in December, to accelerate the writeoff, rather than waiting until January, when they’re due. Even though your estimated tax obligation is $5,000, your tax advisor might tell you to pay only $3,000 in December. That $3,000 payment is projected to reduce your regular tax bill but paying the additional $2,000 would throw you into the AMT and effectively waste the prepayment.
Investments. You need to be careful when investing in municipal bonds. The interest paid by some bonds is taxable, not tax-exempt, for individuals subject to the AMT. So read the disclosure documents carefully before buying munis and check with your tax pro if AMT exposure is indicated.
The same is true if you’re investing in a municipal bond fund, many of which hold some AMT bonds. If 40 percent of a fund’s portfolio consists of AMT bonds–which might be the case with some “high yield” muni funds–then 40 percent of the income dividends paid by the fund will be taxable, for those subject to the AMT.
