If you've already run the numbers on your 2003 return, you may have gotten an ugly surprise on Line 42. If you haven't completed your Form 1040 yet, look out.
The dreaded alternative minimum tax (AMT) will blindside more than 3 million taxpayers this filing season, most of them middle- and upper-middle-class couples with children. And it will only get worse unless Congress changes the law.
What's the AMT?
The AMT is a complex tax concept created in 1969 to make the super-rich pay some income tax. It forces you to calculate your income tax liability using the conventional method and the AMT method, and then pay whichever is higher.
To calculate the AMT, you include some "tax preference" income items that are excluded from the regular calculation, and you lose some deductions that are allowed for regular tax purposes, which means you'll have a higher income base for the AMT. Finally, you apply the tax rates on AMT (26 percent and 28 percent), which is lower than the regular tax rate.
Exemption levels set by Congress help shield many people from the AMT.
The big problem: Those exemption levels haven't kept up with inflation, forcing millions more to pay the AMT in coming years unless Congress dramatically raises the AMT exemption. The current level spares most taxpayers with incomes below $100,000.
Who's most vulnerable?
The tax calculation is actually a lot trickier than it first appears.
Essentially, the people most vulnerable to the AMT are those with large miscellaneous deductions or lots of capital gains, people who exercise stock options, taxpayers with depreciation deductions on business equipment or investment real estate, and people who pay lots of state and local property tax in relation to their income.
How to respond
It's too late to do anything about your 2003 taxes. But you can start thinking about avoiding the AMT on your 2004 return.
How? People who pay the regular income tax typically aim to grab de-ductions in the current year and push income into next year. But if it's likely the AMT will hit you, it may actually pay to do the reverse—postpone deductions until later years and accelerate income into the current year. (For more details, see box below.)
Bottom line: If you're a likely candidate for the AMT in 2004, talk to your tax adviser regularly as the year unfolds, reporting on how your finances are progressing. That way, you can make the right moves to bring your tax bill down to where your AMT and regular tax liabilities are about equal. If you wait until November or December 2004 to analyze your tax status, it will probably be too late to do much about it.