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YEAR-END PLANNING TIP: BEWARE THE ALTERNATIVE MINIMUM TAX

December 04, 2003

What do these Iowans have in common?

- A three-child household with two parents earning $95,000 each.
- A widow with a large capital gain.
- A single doctor with taxable income of $200,000 and a new house.

Your choices:

A): They wish Slipknot and Yanni would work out their creative differences.
B): They TIVO the House Ways and Means Committee hearings on C-SPAN.
C): They are likely to incur alternative minimum tax (AMT) this year.

As odd as it seems to some of us, "C" is the correct answer. The new tax law lowered the regular tax rates, with 35% now the highest regular rate. The AMT rates, however, were not lowered. The top stated AMT rate remains 28%, but deduction phaseouts make for a 35% marginal rate at some income ranges. AMT is computed with fewer deductions, exemptions and credits than regular tax; it applies if it exceeds the regular tax. Now that the regular rates are closer to the AMT rates, the AMT will apply more often.

WHAT TO DO?

A number of taxpayers are doomed to AMT, but others might avoid it by careful planning. Some ideas:

Project your 2003 and 2004 income taxes. It's asking a lot to compute your taxes now when you have to do it for real in April, but a good projection is essential for AMT planning.

Match your state income tax payments with your income. State and local taxes are not deductible in computing individual AMT. Taxpayers with unusually high income this year - say, as a result of a big capital gain - are much more likely to have AMT next year if they don't prepay some of their state taxes before December 31. The two-year projection can tell them how much state tax to prepay.

WHAT IF YOU ARE STUCK WITH AMT ANYWAY?

Sometimes AMT is unavoidable. If so, you should avoid some of the standard tax planning tricks. For example, you shouldn't prepay your March property tax installment, and you should wait until January to pay your fourth quarter state estimated taxes.

Some standard tax planning tricks still help when AMT strikes. You may reduce AMT if you:

-Take capital losses to the extent of capital gains, plus $3,000.

-Make charitable contributions with appreciated property.

-If you own a Schedule C or pass-through business, accelerate business deductions.

ACCELERATE INCOME?

A few taxpayers - if they are sure they have AMT this year and will be top-bracket regular taxpayers next year - may even want to move some income from 2004 up to 2003. This strategy might make sense because the 28% top AMT rate is lower than the 35% top regular tax rate. This requires reasonably predictable income and a good projection. Don't try this at home, kids.

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