Taking capital gains may move you from the regular income tax to the alternative minimum tax (AMT). When this happens, the effective rate on your gains will exceed 15 percent. That’s because taking capital gains may cause your “AMT exemption” to be phased out.
In 2005, this exemption is $40,250 for single filers and $58,000 on joint returns. However, once your taxable income for AMT purposes exceeds $112,500 ($150,000 on joint returns), the exemption phases out, 25 cents on the extra dollar of income.
When your income is in the phaseout range–say, between $150,000 and $382,000 on a joint return–you’re not only adding taxable income, you’re paying more tax because you’re losing the AMT exemption.
In some situations, the effective tax on long-term gains might be much higher than 15 percent For a couple filing jointly with $200,000 in ordinary income and a $150,000 gain, for example, the effective tax rate would go up to around 21 percent, for AMT purposes.
Your state may impose a capital gains tax, too, and state taxes aren’t deductible from AMT income so this added tax can be especially painful, in a year you must pay the AMT. Therefore, it might pay to spread out long-term capital gains over two or more years, to reduce the effective tax rate.
