To top it off, Henry discovered that after saving diligently for retirement, his investment income was going to be highly subject to alternative minimum tax (AMT). AMT is an extra tax that certain taxpayers must pay in addition to the regular income tax. What Congress intended for AMT was to prevent taxpayers with substantial income from using tax "loopholes" (such as certain exclusions, deductions, and credits) to pay little or no tax. These taxpayers must pay at least a minimum amount of tax.
The AMT tax code is dated. Little has been done by Congress to fix it. It hasn't been indexed along with other areas of the IRS code. It is a very complex area of tax planning affecting many every year.
Factors that could give rise to AMT liability are:
a.. Large numbers of personal exemptions
b.. High miscellaneous itemized deductions
c.. High state or local taxes paid
d.. Large capital gains
e.. High medical expenses deducted
f.. Exercising of large incentive stock options
To calculate AMT, individuals use IRS Form 6251. The 2006 AMT exemption amount for married filing jointly is $62,550 and for singles, $42,500. AMT rates are 26% on amounts up to $175,000 and 28% for amounts above $175,000.
Henry pays a large Oregon income tax bill, a tax preference item. He also invested about one third of his after-tax investment portfolio in high income securities, half of which are non-qualified dividends subject to AMT. He holds some investments which have done very well. Last year was a good one and they dumped an unusually high capital gains distribution at year-end.
He finds that under AMT most of his investment management expenses, accounting bills and other miscellaneous deductions are not allowed. To say he is frustrated would be an understatement. Finally, he won't move out of state like many of his friends to avoid paying Oregon income tax.
Here are some of the ways to restructure tax planning for those with AMT sensitive circumstances.
a.. Consider Oregon double tax-free municipal bonds -- effective in any state and local municipals which are double tax-free.
a.. Make sure dividends are "qualified", since qualified dividends are not subject to AMT as nonqualified dividends are. Qualified dividends are taxed favorably as well at 15% federal income tax, while non qualified dividends pay the ordinary tax rate or AMT rate.
a.. Own individual stocks or tax managed instruments that have little or no automatic capital gain distribution. In a large after tax portfolio, the unknown distribution of capital gains can be paralyzing to other tax planning done during the year.
a.. Personal Refundable Tax Credits including the earned income credit and some nonrefundable personal tax credits. These credits include: The adoptions tax credit, the child and dependent care credit, nonrefundable portion of child tax credit, credit for the elderly or the disabled, the Hope credit and Lifetime Learning credit, Tax credit for IRAs and retirement plans("savers" credit).
a.. Oregon Tax Credits -- State Film Office Tax Credit, Energy Tax Credits and IDA Tax Credit, Childcare Contribution Credit. These credits are issued and sold out.
Henry wants his tax burden to be predictable and not punitive. He is willing to take a one-time capital gain hit to revamp his portfolio to insulate against what he feels is confiscation from AMT.
Your ability to dodge the AMT depends on your situation. You might want to defer any deductions and tax benefits that trigger the AMT if you think you'll be subject to it this year. AMT planning is complex, so start early in the tax year.