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Alternative Universe

Nothing this side of the Boston Tea Party has raised as much ire as the alternative minimum tax, but there are things you can do to keep from getting mugged.
Marie Leone, CFO Magazine
December 1, 2006

It has been called "illogical," "horrific," "a slow-motion train wreck," and, most colorfully, the "roach motel" of taxes: you check in but you never check out. The alternative minimum tax (AMT), dreamed up by Congress in the late 1960s to make sure the rich don't exploit tax loopholes, now affects more than 3 million American taxpayers, and could apply to as many as 31 percent of all taxpayers by 2010.

Today, most people who pay the AMT make between $75,000 and $400,000 a year — above the national average, but far from rich. And while Congress used the same "tax the rich" political rhetoric in 1986 when it revised the law, those changes actually seem to have widened the pool of taxpayers subject to the AMT.

Critics say that the AMT is a misguided effort to close tax loopholes that were eliminated 20 years ago. The rules that govern the AMT create a sort of alternate tax universe, one in which a slew of popular deductions cherished by the middle class (state, local, and property taxes; children; mortgage interest under certain circumstances; and others) are replaced with a single exemption that has not kept pace with inflation. If a taxpayer is subject to the AMT, he or she pays at or near the highest tax rate on all income, versus paying a progressive rate that reaches the 28 percent maximum level only on income above $74,000.

Can't Go Home Again
Based on data from the Internal Revenue Service, the average AMT filer paid an additional $6,000 in taxes in 2004. Other calculations put the average tax hike at more than $13,000 for someone making $100,000 annually (assuming a tax base after deductions of $71,000).

In one way, unfortunately, the AMT is an undeniable success: it is written to make it very hard to avoid. The fundamental strategy for escaping it is to analyze your potential deductions and any income that you may be able to time (such as stock sales) so as to avoid slipping into the AMT's grasp. "You have to run the numbers again and again" looking for the optimal combination of deductions and income that will keep you rooted in the conventional tax system, says Alan Dlugash, a tax accountant with Marks Paneth and Shron who works with high-net-worth clients.

Movin' to Montana
One way to avoid the AMT is to kick the kids out and move to Montana. That's cold (in more ways than one), but it illustrates the frustrations posed by the AMT. The $3,300 (inflation-adjusted) deduction families receive for each member is ignored in the AMT calculation, so larger families often find themselves within striking distance of the AMT even if their incomes are fairly modest. State and local taxes account for 48 percent of the preference items subject to AMT but not to regular taxes, so wage-earners living in high-tax states like New York, California, and Massachusetts are also ripe for the AMT.

If moving to Montana is not an option, some more-reasonable steps include:

Marie Leone is senior editor of

Doing the Math

While alternative minimum tax calculations can be complex, you can conduct a fairly simple exercise to see if you'll be forced to pay it. The math starts with ordinary income. To that, add back disallowed deductions or preference items that are excluded from income under the regular tax systems. Then subtract the AMT exemption for your income level. Using the tax rate schedules, calculate your AMT income tax liability. If the resulting figure is greater than your regular taxable-income calculation, you are subject to the AMT, says Jere Doyle of Mellon Financial.

The AMT exemption is, in effect, a substitute for all the other deductions and exemptions you have to forgo. It is not indexed to inflation and, in fact, was actually reduced in 2005. The maximum exemption for 2006 for an individual filer is $40,250; for couples filing jointly, the exemption is $62,500. The exemption equals $250 for every $1,000 of taxable income earned above a threshold (currently set at $112,500 for individuals and $150,000 for couples), but eventually reaches a limit so that by the time an individual reaches $273,500 in income or a couple reaches $382,000, the exemption maxes out and you are on the tax hook for every dollar. No wonder some financial planners suggest that AMT actually stands for "alternative maximum tax." — M.L.