WHAT YOU NEED TO KNOW ABOUT THE ALTERNATIVE MINIMUM TAX (AMT)

 AMT BASICS:

The AMT has a completely different set of calculations than the regular tax. For the regular tax, you add up your total income, subtract out various deductions to find taxable income, then calculate the tax. Against the regular tax you can claim various credits to reduce your tax even further. The AMT, however, has a different base of taxable income and different tax rates. Taxable income for AMT purposes does not allow the standard deduction, personal exemptions, or certain types of itemized deductions. Also some income which is not subject to the regular tax is added for AMT purposes. Your tax under AMT rules may be higher than your tax under regular tax rules.

When calculating the alternative minimum tax, various adjustments are made. Some income is added which is not subject to the regular tax. Some deductions are adjusted downwards or eliminated entirely. These adjustments function to re-calculate taxable income, the base on which the alternative minimum tax is calculated.

The following tax items are added back to taxable income for AMT purposes. If any of these deductions are significant, this can trigger an AMT liability. •State and local income taxes,

•Medical expenses,

•Miscellaneous deductions such as employee business expenses

•Mortgage interest on home equity debt

•Accelerated depreciation

•Exercising (but not selling) incentive stock options

•Tax-exempt interest from private activity bonds

•Passive income or losses

•Net operating loss deduction

•Foreign tax credits

•Investment expenses

This list is not comprehensive, but reflects the typical adjustments I see that can trigger an AMT liability.

Typically, the alternative minimum tax eliminates most or exactly all of the regular tax savings from the above-mentioned deductions.

How The AMT Works

The AMT functions just like the federal income tax system. It has its own forms, rules and tax brackets. However, the rules of the AMT were created specifically to erase many of the tax loopholes found in the standard federal tax code.

If you are subject to the AMT, you may have to fill out and file a separate set of tax returns. This is in addition to filling out the standard federal tax forms. In the process of filling out both returns, you will calculate your federal income tax under both systems.

After you have calculated the amount of taxes that you must pay under both tax systems, you will be required to pay the higher tax bill. Since the AMT system was created to close tax loopholes in the standard system, the tax bill associated with it will likely be higher than the standard federal tax bill.

Who Might Have To Pay the AMT

There is an income exemption associated with the AMT. This means that if your income falls under a certain amount, you will not be subject to it. The exemption amounts tend to increase every year. For 2014, if your individual income is less than $52,800 or your joint income is less than $82,100, then you will not be subject to the AMT.

However, if your income is above these levels, you might find yourself subject to the AMT if

• You made substantial deductions for your state income taxes.

• You made substantial deductions for dependent exemptions. This could apply to you if you have a lot of children.

• You made substantial deductions for interest on a home equity loan that is used for purposes other than home improvements.

• You earned substantial investment income from certain municipal bonds.

• You exercised “deep in the money” incentive stock options.

Don’t assume that the AMT only applies to wealthy individuals.

How to Avoid or Reduce Your Exposure to the AMT

Although the AMT was created to be difficult to get out of, there are a few things you can do to reduce or eliminate your exposure to it.

Reduce Or Eliminate Your Investments In Municipal Private Activity Bonds: Most municipal bonds are exempt from both federal income taxes and the AMT. However, the interest from municipal bonds that are used to fund private activities such as sports arenas, hospitals and housing projects (to name a few) are fully taxable under AMT. You can reduce your exposure to AMT by reducing or eliminating your investments in these types of bonds. Keep in mind that your interest dividends from bond funds or mutual funds that hold private activity bonds will also be subject to the AMT.

Don’t Take Out A Home Equity Loan For Anything Other Than Home Improvements: The AMT will not allow you to deduct any interest on the loan unless the loan proceeds are used for home improvements. Avoid using your home equity line for non-home improvement purposes.

Decrease Your AMT Taxable Income For The Year: It might sound counterintuitive, but finding ways to slash your income that could be taxed under the AMT will help you reduce your exposure to the AMT. Consider deferring a year-end bonus into the next year. If you have some poorly performing investments, sell those at a loss to reduce your taxable income.

More and more people are finding themselves victims of the alternative minimum tax.