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AMT TAX PLANNING IS DIFFERENT

December 08, 2004

Many taxpayers got an unpleasant surprise last April when they discovered that they were subject to the Alternative Minimum Tax. The AMT is a shadow tax computed at a lower top rate, with a large standard exemption but fewer deductions. It applies when it exceeds regular income tax.

The 2003 tax changes that lowered the regular tax rates did not change the AMT rates. This change often reduced regular tax enough to make it lower than the AMT. Surprise!

The item that causes AMT for most Iowans, and residents of other high-tax states, is the deduction for state and local income and property taxes. Now that sales tax are deductible in lieu of income taxes for regular tax (but not AMT!), residents of other states will be joining the AMT party.

CAPITAL GAIN AND AMT

While the same long-term capital gain top rate of 15% applies for both AMT and regular tax, taxpayers with large capital gains often find themselves facing AMT. Why? Think about it: a 15% tax with fewer deductions is likely to exceed a 15% tax with more deductions. If you are paying the top 8.98% rate on Iowa capital gains, you can get to AMT in a hurry.

WHO IS LIKELY TO SEE AMT?

For Iowa taxpayers AMT is widespread, and often impossible to avoid, for gross incomes between $150,000 and about $500,000. If your income includes large capital gains, this income range widens. If you are blessed with children, the AMT applies at lower income levels because there is no AMT dependent exemption.

HOW AMT PLANNING IS DIFFERENT

The common tax planning strategy of prepaying state and local income and property taxes by December 31 generally fails when AMT applies. Sometimes you can maximize the value of these deductions by paying just enough before December 31 to move you to the verge of AMT.

Other strategies still work for AMT. Charitable deductions are fully deductible for AMT, for example. Home mortgage interest on "acquisition" indebtedness - the loan to buy or remodel a residence - is also deductible, but home equity loan interest is not deductible for AMT.

To do serious AMT planning you need to compute projected taxable income for both 2004 and 2005. Timing discretionary income and deductions among years is often the way to minimize taxes when AMT lurks.

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