Sneaky tax may catch up with you next
If your family income is above $75,000, chances are you may be caught by the dreaded Alternative Minimum Tax in the next few years if you haven't already. The culprit may have been large capital gains, the exercise of incentive stock options or the mere fact that you live in Oregon, which by virtue of its 9 percent state income tax has one of the highest taxes in the nation.
'Sadly, I've had many clients who have been caught by the AMT, and invariably the situation was that they had capital gains which were disproportionately large in relation to their earned income,' says Raymond Rowntree, a certified public accountant and financial planner with Brown Armstrong, a Portland accounting firm. 'People need to be aware that it's out there and take appropriate steps if they're subject to it.'
Created in 1969 to make sure that the wealthiest fraction of Americans could not escape paying income tax like the rest of us, the AMT has now changed into a greedy monster that devours the middle class as well.
The Alternative Minimum Tax is basically a 'parallel tax universe that has its own set of rates and its own set of rules for deductions,' says Mark Luscombe, a certified public accountant and tax attorney who is the main federal tax analyst for CCH, a provider of tax law information.
Because the regulations are complex and confusing, and because no single factor may be decisive, the only way you can tell if you owe the AMT is to do your taxes twice. First you figure your regular federal tax, next you calculate your AMT, and then you pay whichever tax is greater.
Some of the items that you can deduct in figuring your regular tax but must add back in calculating the AMT include:
High levels of itemized deductions. The deduction you claim for state income tax and local property taxes ÑÊwhich can be very high in Oregon ÑÊcan in itself trigger the AMT.
'One strategy is to delay paying your property taxes until a year when you're not subject to AMT,' Rowntree says. 'Even if you incur a penalty, it's usually less than what the AMT would be.
'And if you think you're going to be in AMT mode for a given year, you certainly don't want to follow the conventional wisdom of accelerating your deductions and prepaying your state taxes by December 31.'
Miscellaneous deductions for such things as unreimbursed business expenses, investment expenses, legal fees and even tax return preparation expenses must be added back as well. In terms of avoiding the AMT, Rowntree notes, 'you're always better off getting your employer to reimburse you directly for employee business expenses.'
Numerous personal and dependent exemptions. These exemptions, which this year rose to $3,000 from $2,900 per individual, are disallowed in figuring the AMT. So a large number of such exemptions can produce a discrepancy between your regular tax and your alternate tax, which can trigger the AMT.
You don't need to have a dozen kids to be caught. Rowntree tells of a couple with about $100,000 in income who wound up subject to the AMT last year simply because they claimed personal exemptions for each of their five children.
Incentive stock options. If you exercise incentive stock options and do not sell the stock before the end of the calendar year, you owe AMT on the spread between the exercise price and the market price.
Rowntree gives the example of someone who exercises incentive stock options for 1,000 shares of stock at $20 per share, while the stock is currently trading at $30 per share. The spread of $10 a share, or $10,000, would be considered AMT income. Let's say that the stock plunges from $30 to $5 before you sell it the following year, and like many in the high-tech field recently, you fail to reap your hypothetical windfall. Sorry, but you're out of luck. You still need to pay the AMT bill.
Even long-term capital gains, which nominally are subject to the same special 20 percent rate for both regular tax and AMT, can push you into AMT territory. The reason is that the gains count in full in terms of figuring your adjusted gross income, which in turn affects how much income you can shield before the AMT exemption hurdle is breached.
One reason the AMT is catching more taxpayers is that its rates and the amount of income exempted from its reach are not indexed for inflation (the joint exemption is $49,000, while the single exemption is $35,750). At the same time, regular tax rates have been dropping, and these reductions mean that the excess of your regular tax over the 'cushion' that protects you from the AMT is shrinking. 'It's getting progressively less at all levels of income,' Luscombe says.
Even though the AMT was designed to catch the wealthiest of the wealthy, more and more middle-class people are running into it. While only 19,000 people owed the AMT in 1970, more than 1 million were subject to it in 1999, according to the Internal Revenue Service.
A Treasury Department study projects that by 2005, 13.4 million taxpayers Ñ including almost one-quarter of those with incomes of $75,000 to $100,000 and almost half of them with incomes of $100,000 to $200,000 Ñ will be subject to the AMT.
Ordinary taxpayers smarting from the sneaky tax have found a sympathetic ear within the IRS. Its taxpayer advocate has urged that the AMT be abolished. The Bush administration also has proposed revamping it, but the outcome is uncertain because repeal would cost the government more than $700 billion in lost revenues over the next decade. That's not an appealing prospect for politicians in these days of budget deficits.