AMT, Alternative Minimum Tax, started out as a good idea. Back in the 1960s, it was discovered that there were a handful of super-rich people who paid little or no taxes at all through elaborate tax shelters while regular Joes paid their fair share. To catch these slick tax avoiders, a secondary, parallel tax system was created so as to guarantee that everyone chipped in. And hey, it worked!
Unfortunately, like many good ideas, AMT didn't age well. It isn't indexed for inflation, which means the harsh rules of this "shadow" tax system is slowly catching up with more and more middle class people. So what is this terrible scourge, you ask? Basically, AMT disallows many of the deductions we take for granted. Let's say you are close to the edge, and this year you got an extra-fat holiday bonus. Unfortunately, that bonus was just enough to push you over the cliff and into AMT territory.
That means a good part of the deductions you've been counting on are disallowed. For example, suppose you live in a high-tax state, such as California or Connecticut. Since you're paying through your nose to the local taxman, the federal taxman allows you to deduct the state tax before raiding your checkbook. But as soon as you cross the line into AMT, you get to pay full federal tax on the money that you used to pay state and local taxes. Have children? Sorry, once you're in AMT-land, you can't deduct a dime. The same goes for un-reimbursed business expenses.
While this is obviously annoying, the real kicker is that many people don't realize that they're there until they actually prepare their taxes. Remember how carefully you filled out your employer's tax forms back when you started? That was done in an effort to calculate your tax burden over the year, so that you would automatically withhold just enough each paycheck end up close to owing or being owed nothing for the year.
Well, since a good chunk of your deductions you were counting on are suddenly disallowed, your tax withholdings are now insufficient to cover what you owe. So, on the evening of April 14th you suddenly realize that you owe an additional $3,000 - and that check has to be in the same envelope as your forms to avoid penalties. This year some 3 million American taxpayers will get sucker-punched by AMT. The future is even worse - by the end of the decade, more than 30 million taxpayers may be in AMT territory. What is perhaps the most ironic is that the President's famous tax cuts actually sped up the AMT crisis. The reason for this is how AMT is calculated.
As mentioned earlier, AMT is a separate, parallel tax system. That means you or your accountant must first calculate your regular tax burden, and then do it all over again using AMT rules. Your bill is whatever is higher, so when the regular tax goes down, well, say hello to the newly surfaced AMT monster. If nothing changes, Government can slash regular taxes to zero in 10-15 years or so and still come out fine since almost everybody is stuck with AMT anyway. This is obviously an absurd situation, and voices are being raised in both parties to change or kill AMT altogether. Time will tell how the political maneuvering plays out, but until then, keep a close watch on the AMT limits. Go to the IRS web site or talk to your accountant to assess your situation.
