Fall Newsletter 2006

 

 

Overlooked Ways to Beat It                     The alternative minimum tax (AMT), originally targeted at just a few millionaires, today increases the tax bills of millions of people-including ever more in the middle class.  Here’s what you need to know about the AMT, including frequently overlooked strategies for minimizing its risk to you...   The Problem   It’s estimated that as many as 5.5 million individual taxpayers will owe AMT on their 2005 returns, including about…   17% of taxpayers with income between $75,000 and $100,000.   39% of those with income between $100,000 and $200,000   78% of those with income between $200, 000 and $500, 000.   By 2010, nearly 30 million people  will owe AMT, Including two-thirds of taxpayers with adjusted gross incomes between $50,000 and $100,000 and 40% of all married couples.   How it works   AMT income (AMT) is computed by taking the taxable income shown on your return and adding back items that are used to reduce tax under regular rules.   For 2005, there is an exempt amount for AMTI of $58,000 on a joint return or $40,250 on a single return.  The AMT applies to AMTI over the exempt amount at a 26% rate on the first  $175,000 and 28% on the rest.   However, the exempt amount is phased out by 25 cents for every dollar by which AMTI exceeds $150,000on a joint return or $112,500 on a single return.   This creates marginal tax rates of 32.5% and 35% during the phaseout range, because for every extra dollar of additional income, $1.25 is taxed.   AMT Snares   Some of the items that most often create AMT liability… State and local taxes.  These aren’t deductible under AMT rules.

Example: If you will owe AMT in 2006, make your last state tax payments for 2006 in January 2007, when you might not owe AMT. Capital gains and dividends.  These aren’t directly subject to AMT, but may increase AMT indirectly by (1) pushing total income up beyond the amount that is exempt from AMT, thus causing other items to be subject to AMT Strategy 1:  Before buying dividend-paying stocks for income, assess their AMT-inclusive tax cost compared with other investments, such as tax-exempt bonds. Strategy 2:  If possible, time capital gains realizations to occur in years you won’t owe AMT.  Example:  An installment sale of a property can spread gain over multiple years. Opportunity:  If you  are in a regular 33% or 35% tax bracket and owe AMT, you can realize short-term capital gains at the lower 26% or 28% AMT rate. Miscellaneous itemized deductions.  These include items such as employee business expenses, investment fees, and legal expenses, and are added back to AMTI. What to do:  Time payments before or after year-end to avoid AMT effects, or seek alternate means to cover the costs.     Example:  An employee who deducts his own business expenses can instead seek an expense reimbursement account from the employer. Incentive stock options (ISOs).  Under normal rules, exercising and ISO to acquire stock shares results in no tax bill until the acquired shares are sold.  But under AMT rules, the discount in the option price becomes taxable AMTI at the time of exercise.  This creates a potentially huge trap that snared many during the tech-stock boom and bust-if the stock then falls in value, AMT may be owed on a gain that no longer exists! Example:  An employee uses ISOs to pay $20 per share for employer stock worth $50.  Under AMT, a $30 per share taxable gain accrues immediately.  If, while the employee holds the shares, they fall in value, he loses part of his gain-but still owes AMT on the full $30.  This is so even if the shares fall to less than $20, so he actually has a loss. Important:  There are ways to avoid this trap under AMT rules.  So, before exercising ISOs, examine the AMT implications. Home-equity interest.  The mortgage interest deduction on up to $100,000 of home-equity borrowing is not allowed under the AMT if the borrowing is not used to add to or improve the home. Saver:  The interest may still be deductible as investment or business interest if the funds are borrowed for-and can be traced to-a legitimate investment or business use. The standard deduction  This is not allowed under AMT rules.  Instead, consider taking itemized deductions for items that are deductible under AMT rules, such as mortgage interest, even though they may total to less than the standard deduction. Dependency exemptions  These are not permitted under AMT. Saver:  Free up your exemptions for others to claim.  For instance, have college-age children claim exemptions for themselves.