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AMT: Are you affected?
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May 31, 1999: 7:19 a.m. ET
Alternative Minimum Tax, designed for the rich, claims more in middle class
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NEW YORK (CNNfn) - The last thing you want to do when you finish your yearly tax returns is sharpen your pencil and start over again.
But if you made a handsome salary, had lots of deductions, or exercised incentive stock options in the latest year, that's exactly what the Internal Revenue Service demands.
Any one of those scenarios can push you into the Alternative Minimum Tax category.
The income trap
The AMT, created in 1978, affects a growing number of taxpayers each year.
In 1990, 132,000 filers were forced to pay the AMT -- generating about $830 million for the IRS. In 1996, the most recent year for which data are available, 477,898 taxpayers were affected, generating $2.8 billion in tax revenue.
Originally, the AMT was designed to prevent the rich from sheltering too much of their income in tax credits and deductions. In essence, it eliminated many of those write-offs and forced taxpayers - especially those with higher incomes -- to cough up at least a minimum amount in taxes.
But now, as salary levels rise, tax professionals and critics say middle class families increasingly are being targeted.
Claudia Hill, an enrolled agent in Cupertino, Calif. and editor-in-chief of CCH Inc.'s Journal of Tax Practice and Procedure, said the main reason more families are affected each year is that the standard deduction allowed under the AMT -- which requires taxpayers to recalculate their tax liability using a different standard deduction -- hasn't kept up with the real world.
"The biggest culprit is the standard deduction for AMT," she said. "It's not indexed to the cost of living (as normal taxes are)."
If it were indexed, she said, the $45,000 AMT deduction granted to married couples filing jointly would be worth $57,000 a year today.
At the same time, Hill said demand in the job market has been strong, which has led to dramatically higher salary levels.
Citing recent IRS testimony, Hill said the number of returns with income levels exceeding $100,000 has risen 56 percent over the last five years.
That may sound like a lot, but for dual-income families living in high-cost areas of the country -- such as New York and San Francisco -- that will only buy you a middle-class lifestyle, she said.
The basics
The AMT is, in essence, a separate tax. It has got its own set of rules and filing requirements. The only way to know if you are liable for the AMT, is to first do your regular tax return, and then go back and fill out the AMT form.
The one that's higher is the one you have to pay.
(Click here for an IRS worksheet that tells you whether you need to file AMT form 6251.)
"The AMT is an entirely different way to calculate your taxes, and it's not really an alternative, as the name suggests," said David Mellem, an enrolled agent and research manager for the National Association of Tax Practitioners. "You have no choice. And it's affecting more and more people all the time."
Currently, the minimum AMT tax rates on ordinary income are 26 percent and 28 percent, depending on your income level. For capital gains, the IRS said the maximum capital gains rates are used.
According to the agency, you may have to pay the AMT if your taxable income, including any adjustments and preference items that apply to you, is greater than your exemption amount.
The exemption amounts are: $45,000 if you are married filing jointly or are a qualifying widow or widower; $33,750 if you are single or head of household, $22,500 if you are married filing separately, or an estate or trust.
It depends on your income and number of write-offs you take, but if you are required to pay the alternative minimum tax, Mellem said you can expect to cough up an extra $500 to $2,500. The tab could be much larger depending on your deductions.
Mass confusion
Making matters worse, many who file the AMT say the process is unnecessarily complicated.
National Taxpayer Advocate W. Val Oveson told a Congressional committee last week that he believes the AMT is "probably one of the most discussed and least understood areas in the tax code with good reason for both."
Oveson works for the IRS, but is charged with representing taxpayers before lawmakers on Capitol Hill.
He went on to say that taxpayers who "Congress never intended to subject to the AMT are and will increasingly be required to calculate the AMT."
If you don't believe him, just ask Tom Criswell.
The 52-year-old executive of a small high-tech firm in Silicon Valley last year coughed up an extra $55,000 in AMT after exercising his company's incentive stock options (ISOs).
"The government looks at that as income, but really you don't have that money in your pocket, it's part of your holdings," he said. "The only way I could pay the tax was to sell the stock."
Criswell, who has kids in college and said his low-six figure salary affords his family an "average" lifestyle in California, had been counting on that investment to help pad his retirement nest egg.
It gets worse. Since he's a company executive, he can only buy and sell the stock during "open windows" that pop up throughout the year. Unfortunately, the window that opened just before the April 15 filing deadline, The stock price was dramatically undervalued when he was forced to sell.
"[The AMT] was designed to force people of means into paying what they owe, but it can't have been meant to put normal people through that kind of mess," Criswell said. "What is has done to normal people is absolutely unbelievable. And until you dig into it, you just don't have a clue."
Families and contractors
Hill said roughly 15 percent of her clients last year were forced to pay the AMT. Some taxpayers, she stressed, are hit worse than others.
"The one group I think that gets shafted each year are those in outside sales," Hill said.
Those workers, including pharmaceutical sales representatives and manufacturers reps, typically get an allowance to cover auto expenses and other business-related costs. The way the regular tax system is set up, however, they are required to deduct those allowances separately on their Schedule A form -- as a miscellaneous item.
The AMT, however, doesn't allow for miscellaneous deductions.
Families with many children also can get hit with the AMT, since the tax does not allow for personal exemptions. It doesn't allow for the standard deductions you would normally get as a taxpayer either.
The AMT does allow for write-offs for medical expenses, but you won't get as much as you would on your regular return. And if you're liable for the special tax, you can kiss those deductions for state and local taxes goodbye too.
One other word of warning: Both Hill and Mellem said tax preparation software is not always effective in flagging users who have to pay the AMT. Some programs, they said, also have a tough time correctly calculating the AMT owed.
"I had one client who said she knew about the tax, but said she couldn't find anyplace to make the adjustment (on her personal tax preparation software)," Hill said.
"It can be horrendous," added Mellem, who said he addressed the problem at the annual NATP conference this year. "There's so much that software cannot possibly know."
More specifically, Criswell said the TurboTax program, which he used before finding a professional, dramatically overstated his family's AMT liability.
A spokesman for Intuit's (INTU) TurboTax software, however, said the product does an "excellent job calculating the AMT." In the millions of copies sold this year, he said, "AMT never came up as a problem."
The upside
If you do fall into the AMT income bracket there is at least one bright side.
If you paid the tax in one or more previous years, you may be eligible to take a special credit against your regular tax. If you're eligible, you should fill out IRS form 8801.
Mellem said the credits only apply to things called "deferral items." An example is exercised incentive stock options.
The AMT also allows you to deduct your interest on home equity products, or loans against the portion of your home you already own. Again, check with your tax adviser. There are some restrictions.
Future unclear
Lastly, if you are among the millions who took advantage of the child and education tax credits last year, you should listen up.
The government last year issued a one-year moratorium that kept the alternative minimum tax from interfering with those credits. Next year, you won't be so lucky.
As the law currently stands, deductions for those credits in the current tax season will not be permitted under the AMT.
"In a way, Congress has done a disservice to the taxpayers," Mellem said. "Instead of having it kick in the first year, they gave them a teaser by giving them the full amount of the credit.
Next year, many taxpayers will expect the full amount and may not get it all, he said.
"They've been promised the lollipop but now they'll just get the stick," Mellem said. "This year, that'll be an issue. The number of [AMT payers] is going to grow very rapidly."
To be clear, taxpayers who take the child and educational credits will still benefit from the tax breaks -- they just won't get as much.
There are a few proposals kicking around Capitol Hill, however, that would extend that moratorium or make child and education tax credits count under the AMT as well. What's the likelihood of that being approved?
"Your guess is as good as mine," Mellem said. 
--by staff writer Shelly K. Schwartz
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