21 April 2006

An AMT Primer

Yes, yes, I know. You just filed your taxes and you don't want to hear another dang word about it. Well, too bad. I do this for a living, so I have to hear about it all the time. There is something that you should pay attention to in the tax/political world. It's the battle over the AMT, and it could hit your pocketbook.

Congress is currently negotiating on the latest round of tax cuts. Well, it's really about extending the tax cuts that Congress passed during President Bush's first term. The House wants to extend the Capital Gains and Dividend cuts that expire in 2008 for two more years fearing a Democratic takeover of one of the houses in 2006. The Senate, which has to be more pragmatic to get 60 votes, wants to extend the higher AMT exemption that expires this year.

What does this mean to you? The AMT is a separate taxing system (yes, I know there's a philosophical debate about whether or not it's truly a parallel system, but cut me some slack) that kicks in after the AMT threshold is reached. For 2005, the exemption was $58,000 for married filers and $40,250 for single filers. The exemption reverts to its pre-2001 levels this year of $45,000 and $33,750 respectively. If you make more than the exemption amount, you have to figure your Alternative Minimum Tax.

The AMT was enacted in the 60s as a response to testimony by the Secretary of the Treasury that 155 people with adjusted gross income above $200,000 had paid zero federal income tax on their 1967 tax returns. The small problem was that Congress in its infinite wisdom didn't bother to index the exemption for inflation, so it's roughly at the same spot it was in 1970. Enter the Bush tax cuts.

AMT disallows many of the deductions that are allowed on your 1040, including state income taxes, medical expenses, and home equity mortgage interest deductions. It also disallows personal exemptions, the ones you get for free for you and the kids. Now, when Congress passed the tax cuts they upped the AMT exemption so that people would not be caught by it. Because of the nature of the AMT, if they simply cut taxes and left the AMT alone a lot of the tax cut would be lost because of the AMT.

What does this mean to you? Well, if the AMT exemption isn't raised, the number of AMT filers will explode from 3.6 million in 2005 to 29 million in 2010 per the Tax Foundation. Who is at risk? Mainly those with large families or large itemized deductions since many of the deductions are disallowed for AMT purposes. The IRS released an AMT Assistant for 2005, but that won't help your planning for 2006. The only real way to see if you are at risk is to do the math yourself. However, taking 10 minutes to do the math now will let you know if you need to up your withholding for the rest of the year so that you don't have a nasty surprise come next April.

If you have a large family (say, more than 2 kids) or have a lot of itemized deductions outside of your home mortgage deduction (but including your home equity loan interest), and make more than the AMT exemption threshold, take a gander through the IRS' AMT section and whip out a calculator. Then find out if you need to adjust your withholding or if you are okay. It's painful, but a lot less so than finding out come April 2007.

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