Cents and Sensibility
Cents and Sensibility
Question: I've heard about an income tax called the alternative minimum tax. Can you explain what it is? Be prepared for alternative
minimum taxAnswer: Don't feel bad, most people aren't that familiar with the alternative minimum tax (AMT). Even the name triggers a lot of speculation. What, exactly, is this tax an "alternative" to? What does the "minimum" refer to? Is it the smallest possible tax that can be assessed? If so, who has to pay it?
Here's a little background on the AMT. First, there has been some type of minimum tax ever since 1969. Because many well-off individuals used credits and tax breaks to cut their tax liability to little or nothing, Congress passed laws requiring taxpayers to calculate their tax liability first under the conventional method and then under the AMT method. They then must pay whichever tax is higher.
Although the AMT rates of 26 percent and 28 percent are lower than the top regular tax rates, the AMT rates are levied on a broader income base, one that excludes personal exemptions and many itemized expenses.
For many years, the AMT affected relatively few people. That may change soon. The number of people subject to the AMT will increase from 1.4 million in 2001 to 35.5 million in 2010, according to the Congressional Joint Committee on Taxation. Obviously, that's a big jump. What's behind it? Consider these two factors:
1) AMT offers no adjustment for inflation.
Most taxpayers have been shielded from the AMT by its large exemption, $45,000 for joint returns and $33,750 for single filers and heads of households, but this exemption is not adjusted for inflation, so as wages and earnings rise each year, more and more people will be subject to the AMT. (The Tax Relief Act of 2001 raises the exemptions to $49,000 for joint returns and $35,750 for single filers, but this increase is, at the moment, temporary. It's set to expire after 2004.)
2) Lower tax brackets force more taxpayers above the AMT threshold.
Under the Tax Relief Act of 2001, the top 39.6 percent tax rate will drop to 35 percent by 2006, while the 36 percent rate drops to 33 percent and the 31 percent rate drops to 28 percent. These new, lower rates, combined with the available exemptions and deductions, mean that regular taxes will now be lower than the AMT for many middle- and upper-income taxpayers. This means that affected taxpayers will be forced to pay the AMT.
If you're subject to the AMT, you deal with more complicated tax returns, and tax planning is more difficult. Since you can't always predict when you'll face the AMT, you can lose valuable tax breaks.
Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com