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Alternative Minimum Tax

Congress created the alternative minimum tax (AMT) over three decades ago to prevent wealthy taxpayers from paying little or no tax due to various deductions, exemptions and other preferences in the tax code. The AMT is essentially a separate tax system that requires people to recalculate their taxes using income that would otherwise be exempt from regular taxation. For many years, the AMT affected few taxpayers but recently, application of the AMT has grown so rapidly that it now affects several million people. If you have questions about the AMT or whether it affects you, talk to an experienced tax lawyer.

Structure of the Alternative Minimum Tax

The AMT is basically a separate tax system from the "regular" federal income tax system. Strictly speaking, it is not an alternative tax, but rather an addition to an individual's regular federal income tax. The definitions of income, deductions and exemptions differ from the regular tax system, so much so that the AMT is essentially a parallel tax system that shadows the regular system. With the AMT, personal exemptions for the individual, spouse and children, if any, are not allowed. In addition, taxpayers cannot deduct mortgage interest or the amount of any state and local taxes they paid. There is an AMT exemption, however. The amount the taxpayer owes under the AMT system is the amount, if any, by which AMT liability is greater than regular tax liability. For a simple example, if a taxpayer owes $15,000 of "regular" tax and the AMT is $15,800, the taxpayer would have an AMT liability of $800.

Why Has the Number of People Affected by AMT Increased?

The main reason the number of people affected by the alternative minimum tax has increased is that, unlike the regular income tax, exemptions in the AMT are not adjusted for inflation. Another factor is that tax credits, particularly the child credit, have caused many middle class taxpayers to have the amount they would owe under the regular tax system to be lower than the AMT.

The expanding application of the AMT tends to impose transaction costs that go beyond the basic difference in tax liability. Taxpayers potentially affected by the AMT must complete a second set of forms, whose definitions regarding income, deductions and exemptions differ from the regular tax system. The AMT may also affect these taxpayers' decisions such as whether to itemize deductions and when to pay for deductible activities. Given that approximately one-third of taxpayers itemize their deductions; the amount of transaction costs involved in examining the potential applicability of the AMT is considerable.

Why Does the AMT Disproportionately Affect Married Couples?

Married couples filing jointly are more likely to be affected by the AMT than unmarried taxpayers with comparable incomes. One reason for this is that married couples typically have more dependents than single taxpayers. Under the AMT, these couples are less able to make use of exemptions and child credits than under the regular tax system. Another reason is that the standard deduction for married couples is larger than the deduction for single taxpayers. In addition to married taxpayers, people who have high state and local taxes are more likely to pay AMT because there is no deduction for state and local taxes under the AMT system.

Current Status

In the past few years, Congress has enacted temporary increases in the basic income levels exempt from the AMT in order to address the increasing reach of the tax. For example, for 2007, the income exemption was raised to $44,350 for a single taxpayer or head of household, $66,250 for married people filing jointly and $33,125 for married people filing separately. These increases only last for one year. Therefore, for 2008, the exemptions will go back down to $33,750 for single taxpayers, $45,000 for married people filing jointly and $22,500 for married people filing separately unless Congress acts again to raise the exemptions. This will likely result in many more people being subject to the AMT.

An experienced tax attorney can assist you in resolving alternative minimum tax liability issues.

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