Meet the Dreaded AMT
Last year, I received a substantial long-term capital gain. Could this make me subject to the AMT?
There's only one way to find out for sure: Fill out IRS Form 6251. We aren't being flippant. When it comes to the AMT, there are no hard and fast rules as to who will suffer. But here's a hint: Married homeowners with kids living in high-tax states who earn more than $100,000 annually need to watch their backs.
Over the next few years, the number of taxpayers who will endure the wrath of the AMT is expected to explode. While an estimated 3.2 million people are projected to pay the tax in 2004, that figure will soar to 33.1 million in 2010, according to the nonpartisan Urban-Brookings Tax Policy Center. In the crosshairs are the upper middle class: 92% of those with annual incomes of $100,000 to $500,000 are expected pay the AMT in 2010.
Why the jump? First, unlike the regular tax system, the AMT, which was created in 1970, isn't indexed for inflation. On top of that are the generous tax cuts we've seen over the past few years. Simply put, you might not be getting the break you expected for 2003. Taxpayers must calculate their bill based on the standard tax system as well as the AMT system — and then pay whichever bill is higher . And thanks to those tax cuts that took effect last year, which didn't apply to the AMT, many filers this year will generate a higher tab using the AMT, explains John Battaglia, a director in the Private Client Advisors practice at Deloitte.
The AMT was created as a way to block rich folks from weaseling out of their tax bills by using creative tax deductions. As a result, under the AMT several big tax deductions allowed under the traditional tax system are denied. This includes: state and local taxes, property taxes, home-equity-loan interest (if the funds weren't used for home-improvement purposes) as well as your personal and dependent exemptions (meaning the deductions you take for your kids). The AMT also treats incentive stock options radically different, requiring taxpayers to pay income tax on the spread between the market price and the exercise price. Without these deductions, some taxpayers face significantly higher bills under the AMT system, says Martin Nissenbaum, national director of personal income tax planning at Ernst & Young.
All of this has resulted in some highly publicized tax nightmares, where families with little income but loads of kids have had to pay a whopping AMT bill. Likewise, folks who exercised stock options only to see their value plummet have been stuck with nasty AMT bills based on long-gone profits. And don't pretend that you didn't know it existed: Should the IRS discover that you should have been basing your tax bill on the AMT, you'll be hit with penalties plus interest.
Have we got your blood pressure rising? Let us help calm you down. For starters, while many people need to calculate whether they are subject to the AMT, most scrape by without actually having to pay the tax. That's in part because the AMT has a large AMT exemption: $58,000 for joint filers and $40,250 for singles. Unfortunately, these figures will be reduced in 2005 (which is another contributing factor as to why more people will pay the AMT in future years). And even in 2004, this exemption begins to be phased out for income greater than $150,000 for joint filers and $112,500 for singles.
Now, going to back to your question, will your $200,000 capital gain trigger the AMT? It's impossible to say. It depends in part on the type of capital gain you have, as well as the other income you racked up last year as well as what state you call home (New York, California and New Jersey could be red flags), your marital status and which deductions you typically take. For a quick check, H&R Block has a handy worksheet.
Unfortunately, should you find that you're subject to the AMT in tax-year 2003, there isn't a whole lot you can do about it, says Bill Gale, co-director of the Tax Policy Center, since the AMT doesn't allow for many fancy tax maneuvers. (If eligible, you could, however, reduce your taxable income slightly by making a deductible IRA contribution; 2003 contributions can be made up until April 15, 2004.) That said, if you've fallen prey to the AMT because of exercising incentive stock options (or a few other esoteric reasons), you could be eligible for an AMT credit next year.
Bottom line? If you don't have one already, now could be the time to find a good CPA.