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ALTERNATIVE MINIMUM TAX: YOU'RE NOT JUST IMAGINING IT

April 10, 2006

It's official. There's a lot more AMT going around lately.

The IRS last week released its latest "Statistics of Income Bulletin." Among other items, the Bulletin documents how the number of taxpayers subject to alternative minimum tax (AMT) jumped from 2002 to 2003. You can see it in the chart below, adapted from one in the Bulletin:

Source: Individual Income Tax Rates and Shares, Mudry and Parisi. SOIB, Winter 2006.

The chart measures how many taxpayers were in AMT in 2003 and 2002, arranged by adjusted gross income (AGI). The number of AMT returns went up 24% from 2002 to 2003. The incidence of AMT increased in the $100,000 - $200,000 range by 11%, but it more than doubled in the $200,000 to $500,000 range.

WHY?

The increase in AMT is largely attributable to the rate cuts enacted in 2001 and the reduced rates on dividends and capital gains. It's a matter of the arithmetic. The AMT is computed with fewer deductions, at purportedly lower rates. When the individual rates were cut the AMT rates stayed the same. Inevitably many individuals found their individual regular taxes lowered below the AMT threhhold.

The arithmetic of the AMT and regular tax rate structure hits the $200,000 - $500,000 bracket the hardest. For most of that range, the tax on a given amount of income under the AMT system is barely under the regular rate. State and local taxes are deductible for regular tax, but not for AMT, so almost everyone in that range who lives in a state with an income tax finds that they owe AMT.

The capital gain and dividend rate cuts also push a lot of folks into AMT, at all income ranges. While the stated rates for capital gains are the same under both system, AMT has fewer deductions. If you have the same rate for two taxes, but one has fewer deductions, the one with fewer deductions tends to be higher.

WHAT TO DO?

The best way to avoid AMT is to project your income and try to time your state and local tax payments to match your income. If you are close to the AMT, you may find that you should get out of muni bonds, which often increase state taxes and push you into AMT. But for many taxpayers, the only way to get out of AMT is to kick thier kids out of the house (personal exemptions don't apply to AMT) and move to a low-tax state like Florida or beautiful South Dakota.

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