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Stealth Tax Spoils the Tax-Cut Party

Tracy Byrnes

AMT. It stands for alternative minimum tax, but for a growing number of people those letters mean America's misery tax.

The alternative minimum tax system was created back in 1969 so that a handful of rich people would stop wiping out their tax bill with credits and deductions.

But now, as a result of that oh-so-sly decision by Congress, 3.8 million people will be hit with the AMT in 2005, according to the U.S. Treasury Department, and not one of them will be rich. The main reason for that is that the AMT is not and has never been adjusted for inflation.

So you won't find Carlos Beltran or J. Lo dealing with this issue at tax time.

But your neighbor next door, who's making $150,000, has four kids and pays plenty of property taxes, has the AMT hanging over his head.

And the problem is getting worse. Sure, recent tax cuts lowered the rates and provided limited and temporary AMT relief. But the AMT system itself has not been adjusted in years. So as the regular income tax rates get lower, your chances of falling victim to the AMT run higher.

Here's why.

The AMT Conundrum

There are two parallel income tax systems in the U.S.: the regular ordinary income tax system and the alternative minimum tax system.

Technically, you have to calculate your tax bill under both systems and pay whichever bill is higher. For those of you who aren't in AMT land yet, you probably had no idea that your tax return was calculated two different ways. When you plug your information into a tax preparation program like TurboTax, it calculates both tax bills without you even knowing.

But to better understand this ridiculous system, let's walk through the process.

First, calculate your regular tax bill. You know the drill here. You take all your income then subtract your dependent exemptions, your itemized deductions, credits for childcare, etc.

The final number is your taxable income and your tax rate is applied to that amount to determine how much you owe Uncle Sam.

Now calculate your bill under the AMT system, which has an entirely different set of rules. Start with your income. But then you don't have much subtracting to do because you're not allowed to count exemptions for dependents. And you can no longer deduct your state, local and/or property taxes. Oh, and you can't deduct the interest on that home equity loan you took out to pay for college. And those miscellaneous itemized deductions, forget those too.

So odds are good your taxable income under the AMT rules is higher than it was under the regular rules. Granted, the highest AMT rate only hits 28%, while under the regular system, your tax rate could pay be as high as 35%. "But the taxable income applied to that 28% is bigger under the AMT system, so the lower rate doesn't really matter," notes Laurie Asch, a senior tax analyst at RIA, a Thomson business providing tax information and software to tax professionals.

As a result, your tax bill under the AMT system could potentially come out higher, even with the lower rate.

Now President Bush wants to make the tax cuts of recent years permanent. Yippee!

Maybe for some.

But lowering those rates only increases the odds that when you figure your tax bill using the AMT rates, the AMT bill will be higher. That's why an estimated 20.5 million people will pay AMT in 2006, says Rande Spiegelman, vice president of financial planning at the Schwab Center for Investment Research. And close to 30 million people will be doing it by 2010. That's one in three taxpayers.

Even worse, folks in the $75,000 to $100,000 income tax bracket are the most likely to get hit over the next couple of years.

Hello, Washington! It's high time you wake up to this.

So What Can You Do?

Aside from writing to your local representatives in Congress (I'm not kidding), if you think you're going to be sucked into AMT land, get help.

Unfortunately, there is no cookie cutter description of who will get hit with the AMT. However, if you have kids, own a home in a high-income-tax state like California or New York, you will most likely to get hit, warns Spiegelman.

So do some legwork. There's not a whole lot you can do for your 2004 return, but you can get a jump-start on 2005. Prepare your 2005 tax return under different scenarios so that you can maximize your situation.

You can try to estimate your 2005 return with a tax preparation program, even though it's not updated with the 2005 info yet, suggests Mark Luscombe, a principal federal tax analyst with CCH Inc., a provider of tax and business law information. At least it will give you a ballpark estimate of what your situation will look like.

And if you have an account with a broker like Schwab, check its Web site, as these sites generally offer planning tools to help you with these situations. Use something.

Here are some things to consider if you're in AMT land or on the cusp of it.

This stuff is ridiculously complicated. So if you're not willing to sit down and learn it (who is?), then get professional help.

And then start complaining. I highly doubt that the average member of Congress, back in 1969, intended for the AMT to be such a burden to so many taxpayers, but it is; and something needs to be done about it.