AMT penalty: The ultimate insult

NEW YORK (CNNMoney.com) -- To figure out whether you need to pay quarterly estimated federal taxes this year and avoid underpayment penalties, you need to have a sense of what your tax liability will be.

But about 20 million taxpayers have no idea - that's because lawmakers haven't passed any Alternative Minimum Tax relief for middle-income and upper-middle-income taxpayers for 2007. Unless they do, those 20 million filers will be subject to the AMT for the first time and they will be hit with a higher bill than they would under the regular tax code.

To add insult to injury, they may risk an underpayment penalty in some cases for failure to have paid enough throughout the year.

To head off that risk, Senator Charles Grassley (R-Iowa), the ranking member on the Senate Finance Committee, said on Wednesday that he would propose legislation that would exempt first-time AMT filers in 2007 from such penalties.

The expectation is that Congress will act to shield the 20 million filers at risk at least for 2007. On Wednesday, Max Baucus (D-Montana), chairman of the Senate Finance committee, said lawmakers would pass at least a short-term patch for this year, although not before dealing with other issues, such as healthcare, according to the publication "Congress Daily."

A patch would include an increase in the amount of income that may be exempted from your AMT calculations. Those income exemption levels haven't kept pace with the times since the AMT's inception almost 40 years ago.

But even if Congress does pass a patch, the Joint Committee on Taxation estimates that 5.4 million tax filers will be subject to the AMT in 2007, up from 4.2 million last year.

Those additional 1.2 million filers also risk underpayment penalties if they don't do a fairly good job of figuring out what they'll owe now and pay estimated taxes throughout the year. Based on interest rates for the first two quarters of this year, you might owe between $75 and $80 for every $1,000 of tax underpaid, said John Roth, a senior tax analyst at tax information publisher CCH.

All tax filers are supposed to calculate their tax liability twice: once under the rules of the regular income tax code and once under the rules of the alternative minimum tax. Then they're supposed to pay whichever bill is higher.

Why can't you just pay the bill you owe when you file your taxes and not be penalized for underpayment? The way the IRS explains it, the U.S. income tax system is pay-as-you-go. That is, the taxes you owe on your income should be paid as you make the income.

You are supposed to file estimated taxes if:

• You expect to owe at least $1,000 on top of the taxes already withheld; and
• The amount withheld from your income throughout the year is less than 90 percent of the taxes you owe for 2007 or 100 percent of the taxes you owed in 2006 (110 percent if your adjusted gross income exceeds $150,000).

IRS Form 1040-ES can help you calculate your estimated taxes.