THIS AMT THING IS OUT OF HAND

May 2005

  Tax day is fifteen days into our rear view mirror and the devious nature of the alternative minimum tax (AMT) plagues more and more of you on an annual basis. The alternative minimum tax was created back in 1970 to close a series of loopholes whereby less than two hundred very wealthy taxpayers were paying nothing in taxes. The number of taxpayers hit by AMT has grown every year since:  up to 1 million in 1999, to 2.6 million in 2003 and by 2010 it is estimated that 33 million taxpayers will be subject to AMT.

Here are the really staggering numbers. It is estimated that by 2010, 92% of taxpayers earning between $100,000 and $200,000 will be subject to the AMT tax and 73% of those earning between $75,000 and $100,000 will be affected. How did this tax become so prevalent? There are two reasons. First, virtually every new tax break since 1986, including the child tax credit, the HOPE credit, the Lifetime learning credit, etc. has been excluded from the AMT calculation. In December, we praised the “make sense” tax law change whereby depreciation on SUVs was limited and a $4,000 electric tax credit for energy efficient cars was implemented. However, the credit was not allowed if you were in AMT. So the perverse result was if you bought an SUV for business use, you still got some tax help even if you were in AMT.   But an individual taxpayer hit by AMT would get no benefit for purchasing the energy efficient car.

The second reason for the increase in AMT is that Congress did not inflation-adjust the income threshold for purposes of phasing out the annual AMT exemption. Regular tax brackets are adjusted for inflation each year. There was no adjustment for inflation from 1991 until a nominal increase in 2001. So now, a taxpayer in a high state, local and real estate tax area such as Pennsylvania and Delaware or someone with three or four dependency exemptions is automatically in AMT. As well, there is an AMT calculation intended to mirror the reduction in tax rates on capital gains and dividends, but a significant capital gain can eliminate some of your AMT exemption so there is an impact regardless. 

The tax code has morphed into a Chinese menu which feels like “now you see it, now you don’t”. Last month, The IRS commissioner testified in Congress that the AMT tax should be junked. However, it is unlikely that elimination will happen because the government’s revenue dollars are great.

So if it’s getting worse and there is not much chance for relief, what can be done? Well, for most of you, not very much. For instance, what can you do to reduce your exemptions? Or, what can you do about state, local and real estate taxes? You may postpone them until next year but the situation will be little better then. You can and should discontinue the practice of over-withholding because you like getting a refund. And we need to think before automatically paying your fourth quarter state estimate in December as you may not get any tax benefit.

Take a good look at your miscellaneous itemized deduction. The AMT tax virtually eliminates any tax benefit from these deductions. First, review your unreimbursed employee business deductions such as your car, travel and entertainment. Your best option is to get your employer to pick them up as an expense and reduce you salary.  Second, review custody and investment advisory fees. Do a cost benefit on these expenses assuming there is no tax deductibility. Finally, in years you are not in AMT, you need to bunch your expenses, state, local and real estate taxes and miscellaneous itemized deductions because it may be the last time you get any benefit.

Lets all hope for AMT tax relief because otherwise there is not much that can be done about it.

Call Geoff Langdon at Cover & Rossiter (302-656-6632) with questions.  Or, you can email us at CoverRossiter@CoverRossiter.com.