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NEW LAW TIP: BEWARE AMT

September 16, 2003

We know that every cloud has a silver lining. Of course, every shiny silver lining has a dark cloud, too. The recent tax law is no exception.

Many taxpayers now dazzled by the bright shiny lining of the reduced individual tax rates of the 2003 tax law will face the dark cloud of alternative minimum tax next April. As we've noted before, AMT looms for more and more taxpayers.

The AMT is a shadow tax system that lurks alongside the regular income tax. It has only two rates - 26% and 28%; a generous exemption; and fewer deductions. If AMT exceeds the regular tax, the AMT applies. For most taxpayers, the biggest regular tax deduction missing from the AMT systems is the deduction for state and local taxes.

LOWER RATES, BUT FEWER DEDUCTIONS

In 2002, when the top individual rate was 38.6%, there was a 10.6% difference between the top regular rate and the top AMT rate. Now, there is only a 7% difference, making it easier to slip into AMT. The tax law increased the AMT exemptions for 2003 and 2004 to help alleviate this, but the exemption - like so many features of the tax law - is phased out at certain income levels. For example, the $59,000 AMT exemption for married taxpayers begins to phase out as income exceeds $150,000.

Iowans with taxable incomes from around $150,000 to $500,000 will find it very difficult to avoid AMT this year; it some cases, it will be impossible. It will be especially difficult for taxpayers with large amounts of dividends and capital gain income. These items are taxed at the same 15% federal top rate for AMT as for regular tax, but Iowa taxes them at the same rate as ordinary income. A 15% tax without a deduction for state and local taxes can exceed a 15% tax with such deductions in a hurry.

WHAT TO DO?

Taxpayers need to be especially careful with their year-end planning this year. Typical strategies, such as paying property taxes and state income taxes before year-end, can backfire when AMT applies. Taxpayers should project their income and carefully evaluate any year-end strategies with AMT in mind.

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