Read an Excerpt
Why You Should be Concerned about Alternative Minimum Tax
Excerpted from Alternative Minimum Tax by Harold S. Peckron ©2005
Imagine that you have completed your tax return for the year and expect a large refund. Some months later, you receive a notice from the IRS that not only eliminates the refund, but also demands an additional sum because of something known as the alternative minimum tax (AMT). Not knowing what this alternative tax means, you ponder whether this is an error.
Welcome to the new world of federal income tax that will begin to affect millions of Americans.
Originating in the 1960's, the alternative minimum tax for individuals was designed to ensure that high-income individuals would pay some minimum amount of tax. That was then. Now the AMT is set to cause financial havoc for most middle-class taxpayers. It is a second, parallel tax, in which taxpayers are hit with a loss of deductions resulting in higher taxes. Think of it, however, as a true additional tax-you must pay the regular tax and, if the AMT is greater, the excess is then added to the regular tax. Result: an increased tax bill.
Because of complexity and tax differences, the AMT poses many challenges to the average taxpayer. In other words, certain deductions that are allowed for the so-called
regular tax (what most taxpayers compute on Form 1040) are denied for the AMT. (More differences between the two tax systems will become apparent as your reading continues.)
On my office wall I have the original tax form that individuals used in the first year of filing their federal taxes in 1913. It is one page in length-including the instructions! Fast forward to 2004. Go to the IRS website-irs.gov-and click on the "Forms and Publications" link. The sheer number of forms will amaze you. And, of course, every time Congress tinkers with the tax law, the relevant forms need to be revised.
Section 2004 of the IRS Restructuring and Reform Act of 1998 requires the U.S. Treasury to develop procedures for a return-free tax system for certain individual taxpayers no later than 2007. Does this mean that you will not be filing a tax return for the regular tax (Form 1040) or the AMT (Form 6251)? Not according to the December 2003 U.S. Treasury Report to Congress. Only about 52 million taxpayers (those primarily with all withholding income) will be exempt from filing. So most individual taxpayers will still need to file using the IRS forms.
A roadmap or diagram of the basic structure of the AMT and the process of calculating your tax liability may help.
Filing Form 6251, the Alternative Minimum Tax-Individuals
First, you must decide whether or not you must file the AMT form. In simple terms-ask yourself whether the taxable income on Form 1040, combined with certain AMT adjustments and AMT tax preference items, exceeds the AMT exemptions.
Note: In 2006, unless Congress changes it, the AMT exemptions of $58,000, $40,250, and $29,000 will revert to their lower respective amounts of $45,000, $33,750, and $22,500.
Example 1:
Maria, a single taxpayer, has a taxable income on her Form 1040 of $75,000, and combined AMT adjustments and preferences of $20,000, for a total of $95,000. Since this
exceeds her AMT exemption of $40,250, she must file Form 6251.
Example 2:
Eldon, a married taxpayer and sole breadwinner, has a taxable income of $40,000, with AMT adjustments and preferences of $10,000, for a sum of $50,000. He will not need to file Form 6251 because his exemption of $58,000 exceeds this amount.
In close calculations, such as Eldon's from the previous example, you should use the worksheet provided in the Form 1040 instructions. After completing your regular income tax return, use the worksheet to determine whether your tax deductions and credits may have reduced your taxes below the AMT threshold. (This can save completing the 55-line Form 6251.)
AMT Exemptions
A key calculation is the exemption amount. An exemption amount means that the taxpayer may have no AMT liability. To further assist a taxpayer in deciding whether it may be necessary to complete Form 6251, the IRS provides an AMT exemption worksheet. The worksheet attempts to simplify the reduction calculations of the exemption amount. The AMT exemptions are phased out once your income reaches a certain level. In 2003 through 2005, the exemption amounts of $58,000, $40,250, and $29,000 are reduced by a formula once your AMT taxable income exceeds:
$150,000 for married filing jointly and surviving spouses;
$112,500 for single individuals; and,
$75,000 for married filing separately.
In certain cases, your AMT exemption amount is completely phased out in 2003, 2004, and 2005 whenever the following occurs.
The AMT exemption phaseout for married filing separately is equal to the phaseout for married filing jointly taxpayers ($191,000 x 2 = $382,000). However, if the married
filing separately taxpayer's AMTI exceeds $191,000, then a special add back computation is required. Such a calculation demands that the AMTI be increased by 25% of the amount over $191,000, limited to the AMT exemption amount of $29,000. So the full $29,000 add back makes the AMTI limit for married filing separately $307,000.
Example:
In 2004, Bart and his spouse file married filing jointly and compute their AMTI to be $175,000. This reduces their AMT exemption of $58,000 in that year to $51,750, as follows:
$58,000 .25($175,000 $150,000) = $51,750
Had the couple's AMTI been $382,000, no AMT exemption would be allowed:
$58,000 .25($382,000 $150,000) = $0
Note: Special rules exist for the AMT exemption available to minor children (under age 14) and are set forth in the Instructions to Form 6251.
It is important that you realize this computation must be performed every year. The fact that you are or are not subject to the AMT in one year has no bearing on whether you are liable for the AMT in a succeeding year. Every year stands on its own.
The AMT is actually comprised of two taxes. Your total tax due is comprised of the AMT and your regular tax. (This makes the taxpayer's AMT burden that of an additional tax beyond the regular tax.)
Example:
Donald and Sue file married filing jointly in 2003. Their regular tax (Form 1040) liability amounts to $18,851.98 and their AMT (Form 6251) liability is $14,864. In 2003 they are liable for a regular tax of $18,851.98, because they pay the larger of the two taxes.
In 2004, their regular tax liability is $25,291.52, but their AMT liability results in $32,555.45. Here, unlike 2003, they owe an AMT liability of $32,555.45 (because it is the larger of the two), comprised of $25,291.52 of regular tax and $7,263.93 of AMT.
(Even though the IRS considers these to be two taxes, you can generally just assume that your tax liability is the greater of the two taxes and need not think of them as two taxes.)
AMT Rates
Another characteristic of the AMT that causes it to affect more and more people every year is that the income brackets tied to its rates are not indexed for inflation. So, for example, if cost of living goes up 3% from one year to the next, the AMT income bracket stays fixed, causing you to have more of your income affected by the AMT rates. The regular tax is indexed for inflation, so generally speaking, every year the size of the income brackets increases for each tax rate percentage.
The actual AMT tax rate is 26% on the first $175,000 of AMTI. Any excess AMTI is taxed at a flat 28%. So, unlike the progressive nature of the regular tax, which has rates
ranging from 10% to 35% and is calculated with tax tables and schedules, the AMT has only two tax rates. All AMTI is either equal to or less than $175,000 or is over $175,000.
Example:
Ron, a single individual, has an AMTI of $300,000. His AMT liability (before credits) is $80,500.
(.26 x $175,000) + (.28 x $125,000) = $80,500
Capital Gains
When you look at Form 6251, you will notice that it is only a two-page form. But on the second page is a section entitled "Part III: Tax Computation Using Maximum Capital
Gains Rates."
When is Part III on page 2 necessary?
Whenever a taxpayer has long-term capital gains that require a holding period that exceeds one year or capital gains distributions taxed at 15% for regular tax (Form 1040) purposes. Such gains and distributions (as from a mutual fund) are also taxed at those rates in the AMT. You must carve out these capital gains. This is the purpose of Part III.
There is an easy way to decide whether a Part III computation may be necessary. If you used Schedule D when completing your Form 1040, review Part III and follow its instructions.
Note: A large capital gain, despite Part III of Form 6251, may disqualify your AMT exemption. Timing of capital gains is important, as the capital gain income is included in the income phaseout of the AMT exemption.
