There is a lingering tax trap that prevents many taxpayers from relief with federal laws passed since 2001. The Alternative Minimum Tax (AMT) is the monster created by the U.S. Congress originally to prevent the very wealthy from paying no tax at back in the 1960s. It now is preventing tax relief for middle-class American families. In 2006, the AMT will affect 3.8 million taxpayers. By the year 2010, it is expected that the AMT will affect 30 million taxpayers. About half of taxpayers having $75,000 to $100,000 in income will be affected by AMT by 2010. The additional AMT tax bill averages $6,800.
The AMT is similar to a flat tax with two brackets, 26 percent and 28 percent. Taxpayers have fewer deductions allowed with AMT, and the credits for dependents, medical bills, state and local taxes including real estate taxes are disallowed. Instead, AMT taxpayers receive a single deduction which for 2006 is $62,550 for married couples and $42,500 for singles. The AMT tax bill is highest for people with annual incomes of $100,000 to $500,000 income range.
The AMT affects many tax planning strategies. Here are a few examples of its impact and planning opportunities to deal with the tax effects.
1. State and local sales and real estate taxes aren't deductible for AMT purposes. Many taxpayers have moved from high-tax states to lower tax states when possible. Another planning point is to consider capitalizing real estate taxes rather than deduct them as itemized deductions when taxpayers are subject to AMT. Capitalized property taxes add to the basis of the property for either investment property or residences when sold in the future. The capitalized property taxes will lower the gain on the sale.
2. Professionals who are taxed as employees usually pay for unreimbursed expenses such as promotion, automobile, travel, and entertainment expenses which can be substantial. For example, a professional with an income over $150,000 may have costs for travel and promotion expenses averaging15-20 percent of their gross income per year. The deductions aren't allowed for AMT tax. One strategy might be to work as a separate self-employed corporate entity. The deductions for automobile, travel, and entertainment expenses would be fully deductible in the professionals company and not limited by the AMT tax.
3. Retirees who decide to sell low-cost-basis securities such as stocks or bonds may be hit by the AMT tax on the sale. A planning tip is to have the taxpayers donate the securities to a charity directly or in the form of gifts such as a gift annuity, or a Charitable remainder trust. The taxpayer receives a donation on the current value of the security, and the donation deduction isn't subject to AMT.
Scott T. Wait is a CPA and a business management consultant practicing in Reno. Contact him at at scott@rswait.com or visit www.rswait.com.
