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Families: Fight the AMT

Tracy Byrnes

11/24/06 - 09:58 AM EST

It's so hard being a parent these days. Between your son's violent video games and your little girl's insistence on wearing shirts that don't cover her belly, who can sleep at night?

To make matters worse, your tax situation is about as straightforward as quantum physics. Between that pesky alternative minimum tax, available kid credits and house deductions, most families are in a big ol' tax quandary.

So let's try to simplify things and offer some year-end tax tips to help ease the complexities.

AMT: A Time-Bomb

The Joint Committee on Taxation estimates that 3.8 million taxpayers will be hit with the AMT this tax season. And if the rules don't change, roughly 30 million tax households will be paying AMT by 2010. That's one in every three tax returns.

Currently, folks who have household earnings between $100,000 and $200,000, own a house in a state with high state taxes and have dependents are the biggest targets.

Try to protect yourself from this monster while you still can. If you think AMT is going to creep into your house this year, get professional help now. You still have time to make some beneficial year-end adjustments. If you're not sure if you're going to fall victim to the AMT, here are a few things that should put you on guard.

  • If you took out a home-equity loan to pay for college, your kid's wedding or that long-awaited trip around the world, you can't deduct that interest under the AMT system. Loans that are used to make improvements on your home are just fine, but when the proceeds go to other miscellaneous life events, you're out of luck. So that could toss you into AMT territory.

  • Generating long-term capital gains can be a blessing and a curse, especially if you're cashing in a big chunk of shares. That additional income can throw you into AMT land pretty quickly, so consider the timing of your sales. And keep in mind that the state income tax you pay on that capital gain is not deductible under the AMT.

  • If you have incentive stock options, don't do a thing until you get professional help. Exercising these things can catapult your tax bill into the thousands if not timed properly.

    • Who Takes Care of the Kids?

    Besides attempting to avoid the AMT, take stock of other possible tax-saving opportunities. For one, if you have kids under age 13 and you pay someone to watch them so you and your spouse can work or go to school, you may qualify for the child and dependent care credit. You can include up to $3,000 of the expenses paid in a year for one child, or up to $6,000 for two or more kids. So keep track of those day-care or after-school-care costs.

    To calculate this credit, you must apply a percentage to that expense number. Anywhere from 20% to 35% of your qualifying expenses will count, depending upon your adjusted gross income. So the minimum credit you'll get is $1,200 (20% of $6,000), while the maximum is $2,100 if you have two kids.

    The credit may also be used if you paid someone to care for a spouse or a dependent of any age who is physically or mentally incapable of self-care. The same limitations apply.

    Big note: If you send your kids to a summer day camp so you and your spouse can work, those costs may be included as part of your qualifying expenses. Sleep-away camp, however, doesn't count because it is considered more of a luxury than a necessity, says Bob Scharin, editor of Warren, Gorham & Lamont/RIA's Practical Tax Strategies, a monthly journal written for tax professionals.

    Ah, the Money Pit

    While we all love our homes, it seems we dump our entire paychecks into their upkeep. That's why it's imperative that you take advantage of the available housing deductions.

    You can deduct interest on a loan of up to $1 million if your loan was used to purchase or improve your residence.

    Same goes for a home equity loan. If the money went back into your home, you've got up to $1 million deduction. But if you used to loan to buy a new car or take a trip around the world, you can only deduct the interest up to $100,000 in interest.

    If you got a new mortgage in 2006, you may have paid points -- a.k.a. loan-origination fees or discount points. Points are extra charges paid up front to get a lower interest rate on your mortgage. If you paid points in 2006, those are deductible.

    On the flip side, if you paid points on a refinancing, they must be amortized over the life of the loan. So if you paid $3,000 in points on a 30-year-loan, you'll need to deduct $100 each year.

    A Few More Year-End Reminders

    • The kiddie tax rules changes for 2006. Now, kids 17 or younger still pay tax at your higher income tax rate. So don't gift appreciated assets to your high-schoolers and expect to sell those assets at a lower tax rate. Use your 18-year-old instead.

    • Go through your portfolio and sell your losers before year-end to offset any other capital gains you may have generated in 2006.

    • Pay attention to the mutual funds that are not in your retirement accounts. They're probably going to be making big dividend distributions any day now, and those distributions are taxable to you. But if you don't like the fund anymore, sell it before it makes those distributions. No sense paying taxes on distributions from a loser fund. Check the fund's Web site for details.

    • Be super charitable before year-end. Even if you write a check or charge your donation, as long as its dated by Dec. 31, it'll count for 2006.

    So good luck -- with the parenting and the taxes. I'm struggling with both, right along with you.

    Brokerage Partners