Taking A Bigger Bite

Prepare: More people are likely to become subject to the alternative minimum tax, but they can lessen the pain.

Your Money

December 12, 2004|By Janet Kidd Stewart

Get ready to hear three little words from your tax preparer that could equal one big headache next April: alternative minimum tax.

More than 3 million taxpayers now fall into the byzantine second tax structure hatched in the 1960s to ensure that the wealthy didn't give their fair share. That includes more than half of all households earning between $200,000 and $500,000, according to the Tax Policy Center in Washington.

Without a fix in the system, the AMT will ensnare more than half of households earning more than $75,000 by 2010, according to the tax think tank.

People making more than $75,000, living in states with high income taxes or property taxes, or with certain large investment gains or hefty debt on a home equity line not attributed to the house itself, are prime AMT targets.

That's because the tax requires filers to calculate their liability a second time under less-generous exemptions than in the traditional tax code. Dependent, sales tax and miscellaneous itemized deductions aren't allowed, for example, and medical expense deductions have a higher benchmark to reach.

While the tax remains a mystery to many, there is evidence taxpayers are catching on quickly as the number of people affected rises. A just-released survey from Boston mutual fund firm Eaton Vance showed 47 percent of people knew about the tax in November, up from 33 percent in March.

Despite the awareness, few investors seem to be doing anything about it. In the Eaton Vance survey, 86 percent said their financial adviser had not even broached the subject of the AMT with them.

But there are several things consumers and investors can do - even a few by year's end - to position themselves if they think they may be hit by the tax in coming years, experts said.

Let's take the drastic items first.

Move

If you pay a lot of state income and local property tax, you get nice, fat deductions off your regular tax that go away under the alternative system.

What are you going to do, move? It's not so far-fetched.

Professor Richard Vedder, an economist at Ohio University who studies taxpayer behavior, said the AMT could cause further migration out of high-tax states. He cited Census Bureau data that showed 2.8 million Americans moved from the 41 states with an income tax to the nine states without it in the 1990s.

"The AMT raises the stakes a bit," he said. "Whatever past statistics show would be accentuated by the growing impact of the AMT."

Ditch the kids

Have a lot of kids throwing you into AMT because your regular tax is reduced by substantial dependent deductions? Get rid of them - at least from a tax perspective.

If you file taxes as a head of household or married filing separately - or if you are divorced or getting divorced - there is wiggle room to maneuver child deductions, which aren't allowed under AMT, and child tax credits, which are.

Financial planners counseling couples through divorce are beginning to split deductions or move them to the spouse without an AMT liability as part of the planning process, said Burt Hutchinson, a Bear, Del., financial planner and tax adviser.

"The typical example is a couple getting divorced in a state with high income taxes. He makes $200,000 and she makes $50,000, but she claims their four kids and it triggers AMT for her," said Dennis Casty, an Evanston, Ill., accountant and financial planner whose company, FinPlan Co., sells tax software that helps clients figure out their optimal strategies.

One possible solution, he said, is to structure the divorce agreement to funnel more money into nontaxable spousal support rather than alimony.

Just as with regular taxes, it's important to watch the Dec. 31 clock. If it makes sense to complete the divorce by year's end to take advantage of the tax implications, it might or might not make sense for AMT purposes.

Chronic or acute?

Some people fall into AMT every year because of high income levels, but others might be subject to it one year and not the next.

For those who fall in and out, it pays to accelerate or defer certain deductions depending on where you fall each year, said John Battaglia, a director at Deloitte & Touche.

"It's opposite thinking from what taxpayers are used to. Under AMT it may make sense to postpone certain expenses, where normally it makes sense to accelerate them," said Mark Luscombe, senior federal tax analyst with CCH, a tax analysis publishing firm in Riverwoods, Ill. "If you'll fall under AMT this year, don't prepay things like property taxes."

You can also recoup some of your AMT expenses in later years if you fall back under the regular tax system. You can do this by filing IRS Form 8801.

Your portfolio

It also pays to scrutinize your investments, said Lane McKellar, a tax adviser in San Diego who also works with TurboTax, the big tax preparation software firm.

"People buying municipal mutual funds or some other tax-advantaged funds may find that they contain some bonds that are taxable under AMT," McKellar said.

Foreign funds carry similar caveats and can trigger the AMT, so it pays to determine sooner rather than later if you'll be hit.

Do-it-yourselfers can run an AMT tax estimator for free at www.turbotax.com/ calculators/estimator to see if they're likely to get caught up in the tax this year.

Your body

Wisconsin recently became the first state to allow organ donors to deduct up to $10,000 in travel and lost income expenses. Nearly a dozen other states have considered a similar measure. If you fall under AMT, the deduction is added back in when calculating the alternative tax, CCH says.

Janet Kidd Stewart is a Your Money columnist.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.