When it comes to taxes, there is a three-letter abbreviation that is even more vile than IRS, and that is AMT. AMT stands for the Alternative Minimum Tax, and while it doesn’t sound too harmful, you really don’t want to pay it.
The AMT was enacted by Congress in 1969 as a way to ensure that the wealthiest taxpayers paid at least some income tax. But now, a disturbing phenomenon is occurring: the AMT has started to catch millions of average taxpayers by surprise. According to the Tax Policy Center, the AMT affected 3.5 million people in 2006.
Rather than be caught by surprise, you should learn about the AMT, how it is calculated, and what you can do to avoid or limit its effects.
How the AMT Works
The AMT is a parallel tax system with its own set of complex rules. If you think preparing your taxes is complicated, just wait until you fill out Form 6251! Actually, don’t wait. Go to the IRS website and download Form 6251 if you think you might be subject to the AMT. It’s more likely to hit single taxpayers who earn $75,000+ or married couples who have income of $125,000 or more, particularly those who have a lot of tax deductions.
The AMT disallows a number of deductions, including personal exemptions, state taxes, real estate taxes, miscellaneous itemized deductions such as investment expenses and some medical and dental expenses, and the standard deduction. Exercising incentive stock options may also trigger the AMT.
To make things even more confusing, the AMT affects some, but not all interest from municipal bonds and disallows the mortgage interest deduction on home equity loans if they are not used for home improvements.
Unfortunately, with only a few weeks left in 2007, there isn’t much that can be done to avoid paying the AMT if you’re going to be subject to it. But, the only way to tell if you’ll owe any AMT is to calculate your income taxes, and then redo the calculations using Form 6251 to see if the AMT applies to you.
If you have unavoidable tax deductions such as a large family or high state income taxes, it can be difficult to escape the grip of the AMT. But when planning for next year, consider accelerating income or delay tax deductions if that will remove you from obligations.
The good news is that if it looks like you will be subject to AMT, you have until April 15th to come up with the money. Determine if you are subject to AMT now so that you aren’t hit with a very unpleasant surprise early next year. It is a lot easier to save a little bit each paycheck over the course of 4 months than it is to try and come up with the money in just a few weeks.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.