Will the AMT Hit You?
The Alternative Minimum Tax, AMT for short, was enacted to ensure that wealthy individuals could not entirely escape taxation by using every legal tax break available. Today, the AMT is becoming a tax trap for the middle class.
Currently, the House of Representatives and the Senate have passed different versions of AMT relief legislation. We will update this newsletter as soon as the House and Senate agree on final terms for AMT relief and the President signs it.
The AMT is also referred to, not whimsically, as the added misery tax. It is a highly complex levy originally structured to ensure the payment of at least something by even the wealthiest individuals who are able to avail themselves of the most sophisticated tax breaks. However, the AMT now affects more and more far-from-wealthy folks who claim common, perfectly legal deductions that they have come to take for granted.
To make it more likely that the IRS gets to collect some taxes from everyone, the AMT counts more items as reportable income and allows fewer write-offs than under the normal rules used to calculate your regular tax bill. AMT disallowances include: exemptions for dependents; the standard deduction, a flat amount based on filing status; and such itemized deductions as state and local taxes and miscellaneous expenses, a category that includes fees for tax return preparation and planning. The IRS collects the higher tax, whether it is figured the regular way or under the AMT.
The AMT and recent tax legislation need to be considered in tandem. Thanks to Tax Acts in 2003 and 2004, the top rates for dividends and long-term capital gains are now reduced to 15 percent for individuals in the top four income tax brackets and 5 percent for those in the bottom two brackets through 2010. Those reduced rates for dividends and long-term gains also apply for calculating the AMT on these two kinds of income.
The 2004 Working Families Tax Relief Act also extends the AMT exemption amounts - $58,000 for joint returns and $40,250 for single returns, but only through 2005. This tactic somewhat softens the AMT's punch, but just temporarily.
AMT exemptions for later years revert to what they were in 2001, unless Congress and the president agree to extend, and perhaps increase them. However, if all our lawmakers do is continue their band-aid approach to what has become the third rail of tax legislation; the AMT is going to capture a steadily growing number of individuals. The hit list includes investors with sizable dividends and long-term gains taxed at a top rate of 15 percent, particularly those in high income or property-tax states like California, Massachusetts, New Jersey, New York and Washington, D.C.
There is, however, a rose among these thorns. True, the reduction of tax rates for ordinary income, dividends and long-term gains means the AMT applies to a lot more individuals, lessening the benefit from these reductions. Nonetheless, the amount you pay for taxes will be still be less than it would have been without enactment of the tax cuts.
Although recent tax legislation has lowered your tax bill, you still should integrate taxes into your financial planning throughout the year. You may be pleasantly surprised to discover the scores of tax-saving opportunities that many individuals overlook year after year.
It remains important to act before December 31 of each year while there is still time to take advantage of tax angles that can generate dramatic savings--if you understand how to get the full benefit of what the law allows.
As always, please do not hesitate to contact us.
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