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What is the alternative minimum tax?

Enacted back in 1969, the alternative minimum tax (AMT) was designed to make sure that high-income taxpayers pay a minimum amount of taxes, even if they have sufficient deductions and credits to reduce their federal income tax liability to zero.

The AMT is like a flat tax. You get a lower tax rate in exchange for losing most deductions.

To calculate the AMT, start with regular taxable income, which includes all your familiar deductions and exemptions. Then make certain adjustments and add back certain "preferences" to arrive at your AMT income. Preferences include personal exemptions, charitable contributions, state and local taxes, certain interest on home-equity loans, and miscellaneous itemized deductions.

After adding back the preferences, you're entitled to an exemption of $49,000 on a joint return ($35,750 for singles). The exemption phases out beginning at $150,000 of AMT income on a joint return ($112,500 for singles).

You then calculate your AMT by applying a tax rate of 26 percent to the first $175,000 of AMT taxable income, and 28 percent to higher amounts. Finally, you compare your AMT to your regular tax and pay whichever is greater.

Who is affected by the AMT?

Congress created the AMT to ensure that wealthier taxpayers, who often have the kinds of income and deductions that qualify for preferential tax treatment, would pay at least a minimum amount of tax. Congress also wrote exemptions into the law, so that middle-income taxpayers wouldn’t be subject to the AMT.

Unfortunately, these exemptions were not indexed for inflation. As incomes have continued to rise, more and more people have found that they need to calculate their tax bill twice — once under regular tax rules, and again under the AMT.

Though Congress has expressed a desire to eliminate the individual AMT, it is still in effect. Every year thousands of middle-income taxpayers find themselves subject to the alternative minimum tax.

Will the AMT affect you?

Do you need to concern yourself with the AMT? You do if you have a lot of dependents or if you claim substantial itemized deductions. You may also be subject to the AMT if you realized hefty capital gains during the year or exercised incentive stock options. Claiming certain tax credits might trigger the AMT as well. And if you are an owner of rental real estate or a capital intensive business, you need to be aware that the amount of depreciation allowed under the AMT is limited.

Don’t forget the AMT in your tax planning. You may be one of those middle-income taxpayers who is now subject to this tax.

Don’t let the AMT cause your tax planning strategies to backfire. To find out whether you might be impacted by the AMT, give us a call now.

Marriage

When planning to marry, don't forget the IRS! Weddings often spring a tax trap known as the "marriage penalty." This penalty applies because many tax rules discriminate against two-earner married couples.

• Standard deduction. For example, the standard deduction for married taxpayers is less than the standard deduction for two single individuals. A couple could pay hundreds of dollars of additional tax on the difference in standard deduction alone.
• Tax rates. If you're married, the combined income of you and your spouse may push you into a higher tax bracket than either of you would be in as singles. This feature in the tax law creates a "penalty" on marriage that gets more severe as two-earner income rises.
• Earned income credit. Wealthy taxpayers are not the only ones who are affected by the marriage penalty. If your income is low enough, you can qualify for the earned income credit. Married taxpayers must report their combined income, but unmarried taxpayers with only a single income to report, find it easier to qualify for the credit.
• Social security benefits. A penalty also hits marrieds receiving social security benefits. If you're married, you must combine your incomes, pushing you over the taxability threshold more quickly than singles. The law may subject a higher percentage of your benefits to income tax, so the penalty for being married increases here, too.
• Other areas. Differences between singles and married couples also exist in the rules governing capital losses, mortgage interest, and rental property losses, to name only a few.
• Planning could help. One way to avoid the marriage penalty is to remain single, but letting taxes determine your marital status is not recommended.

However, if you're planning a year-end wedding, you may want to consider delaying your marriage until next year. Not all married taxpayers pay more. Whether you will depends on many variables. We can help you determine whether the marriage penalty affects you, and what, if anything, you can do to minimize it.

Divorce

If you're going through a divorce, taxes may be the last thing on your mind. But divorce involves many potential tax traps and pitfalls. Here are some things to watch out for.

• Alimony and child support. Alimony is taxable income to the person who receives it and deductible by the person who pays it, as long as it meets certain specific tax requirements. Child support is neither taxable nor deductible. A divorce agreement should clearly spell out the difference between alimony and child support.
• Property settlement. When a divorcing couple agrees to a property settlement, there are no immediate tax consequences. But when it comes time to sell the property, one of the parties could be in for a nasty tax surprise. That's because each spouse receives property with its original tax basis, and a low tax basis may trigger a large capital gain down the road. A truly equitable property settlement should consider the tax basis of assets, not just current market value.
• Children. After divorce, the parent who has custody of a child for the greater part of a year generally has the right to claim that child as a dependent. However, the custodial parent may transfer the dependency exemption to the other parent by signing the appropriate IRS form. Why would you ever give away a deduction? Because it may be worth more to your ex-spouse. In exchange for the dependency deduction, you may be able to bargain for more alimony or a larger property settlement.
• Tax filing. As a married couple, you probably have been filing a joint tax return. But during divorce proceedings, you may be better off filing separately or, if you qualify, as head of household. Once the divorce is final, your filing status will be either single or head of household. To qualify as head of household, certain requirements for dependents must be met.