Alternative Tax Can Yield Ugly Surprise

The Charlotte Observer, N.C

Amy Baldwin

January 12, 2004

Jan. 12--Some of us who thought we'd pay less this year because of President Bush's tax cuts could be in for a nasty surprise: the alternative minimum tax.

Experts say more filers will be paying higher taxes this year and future years because of it.

Out of 131 million tax filers, 2 million face AMT now. That number is expected to surge to more than 30 million by 2010, according to the Urban-Brookings Tax Policy Center in Washington. That means as many people would pay AMT as have mortgage interest deductions.

Of those 30-some million, the policy center projects that most will be households with annual incomes exceeding $100,000.

However, many households making $50,000 to $100,000 a year also could be susceptible.

Homeowners with large incomes living in high-tax states and maintaining stock portfolios are most at risk.

"The one negative that occurred out of this (latest tax break) is the AMT. This is something that most taxpayers have not been exposed to before but more of them are now," said Robert Lyerly, partner in Pricewaterhouse Coopers' personal finance service group in Charlotte.

Congress established AMT in 1969 to prevent super-wealthy individuals from using tax shelters and deductions to sidestep their fair share of taxes. AMT is a tax that is added to your regular income tax if your various deductions and sheltered income result in too skimpy a tax bill. AMT is calculated on Form 6251 in conjunction with the conventional Form 1040.

There's no hard and fast rule to determine whether you will be hit with AMT, but there are likely triggers, which include whether you had high ordinary income, reaped large capital gains, exercised incentive stock options or had big state income tax bills.

These days, more of us are vulnerable to AMT for two reasons. First, AMT was not indexed for inflation, meaning there is no allowance for incomes rising to keep up with price increases. Regular income tax, however, was indexed for inflation in 1981.

Second, tax cuts like the one in 2003 have reduced tax rates for the regular tax but left the AMT largely untouched. Lower taxes leave taxpayers with higher income, and higher income is precisely one of the factors that can lead to AMT.

While the new tax law increased the AMT exemption for 2003 and 2004 -- to $58,000 for married couples and $40,250 for singles -- tax pros say in many cases, it's not enough to offset the degree to which incomes will increase due to the lower taxes.

State income taxes and mortgage interest -- tax deductions for many people -- also are likely AMT triggers. The AMT system doesn't allow for those deductions. Thus people who live in states with high income taxes, such as North Carolina with a rate of 8.25 percent, are more susceptible to paying the AMT, said Michael Radford, a certified public accountant and president of the Charlotte office of Asset Management Advisors.

"Anybody with a six-figure income in the state of North Carolina and who owns a home could be subject to AMT," he said.

It is somewhat less of an issue in South Carolina, where the state tax is 7 percent, he said.

Having large capital gains also increase chances of paying AMT. The stock market posted a big advance in 2003, its first gain in four years -- another reason why AMT is becoming a bigger issue. However, some might still have capital losses to carry over from the three previous bear market years.

If you want to know if you must pay AMT, you must complete Form 6251.

Start sharpening those pencils, because calculating AMT is a chore.

You must take into account more than two dozen different deductions and sources of income, from the obscure, such as one that applies to owners of oil rigs, to the more common, such as those dealing with capital gains.

If you want to avoid paying AMT next year, start planning now. You can take steps, such as prepaying your 2004 state income tax, that could lessen your AMT risk.

Tom Wilkens, managing director of RSM McGladrey's N.C. office, suggested working with a tax professional to come up with a tax projection.

He said that having to pay the AMT "does come as a surprise to most people, and the only way you can avoid is to project your tax position prior to the end of the year."

To do a 2004 projection, the pros suggested either consulting your accountant or getting a revised tax schedule and working off your 2003 taxes.

GET ANSWERS

Have a question about your taxes? Chances are you'll find all the answers -- from what the new standard deductions and income tax rates are to information on how to get the appropriate forms or file electronically -- on 1040 Central, which debuted last week, at www.IRS.gov. The resource also provides answers to frequently asked questions and allows you to track the status of your refund.

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(c) 2004, The Charlotte Observer, N.C. Distributed by Knight Ridder/Tribune Business News