Will You Get Nipped By the AMT in 2007?
The Alternative Minimum Tax (AMT) originally was created to counter tax shelters employed by high-income taxpayers. However, over the past few years, primarily due to inflation, the AMT has begun affecting middle-class taxpayers, which was not the original intended purpose. The AMT has become a political hot potato, because to abolish or reform the AMT results in the loss of tax revenues that must be made up elsewhere.
Because it is made up of numerous additions and adjustments to income and deductions, the AMT is a complicated computation. The vast majority of these differences generally don’t affect the average taxpayer. However, there is a handful that impacts almost everyone and is creating the unintended problems. Here is a list of those differences:
Medical: For taxpayers who itemize their deductions, medical expenses in excess of 7.5% of the taxpayer’s income (AGI) are deductible for the regular tax computation. For the AMT computation, only expenses in excess of 10% of income are deductible. This places an additional tax burden on those already burdened with higher medical expenses.
Taxes: Taxpayers who itemize can deduct the taxes that they pay for real property taxes, personal property taxes and state income tax or sales tax. For AMT purposes, taxes are not deductible, resulting in a form of double taxation. This is one of the largest areas of adjustment for the AMT, since just about everyone who itemizes either pays property tax, state income tax or both.
Home Mortgage Interest: The recent refinancing boom had many homeowners taking equity out of their homes for purposes other than home improvement, unwittingly creating the possibility of the AMT for themselves. Generally, for regular tax purposes, taxpayers can deduct interest from their home acquisition debt and up to $100,000 of the equity debt for their home or second home, including interest paid on the debt for purchases such as motor homes and boats that qualify as a home or second home. However, for AMT purposes, interest on the equity debt, including the debt for motor homes and boats, is not deductible.
Miscellaneous Deductions: There are two classes of miscellaneous itemized deductions. The more frequently encountered class includes deductions related to employee business expenses, investment expenses, tax preparation costs, etc. For regular tax purposes, these deductions are allowed only to the extent that they exceed 2% of a taxpayer’s income (AGI). For AMT purposes, these deductions are not allowed at all, creating a substantial difference for many taxpayers.
Personal Nonrefundable Tax Credits: Generally, nonrefundable personal credits (except for the adoption credit, the child credit and the saver's credit) normally are not allowed against the AMT. For several years, through 2006, Congress has made special provisions allowing these credits to offset the AMT. However, beginning in 2007, without further Congressional action, these credits will no longer offset the AMT. These credits include the child and dependent care credit, the hope and lifetime learning credits, the elderly credit and the mortgage credit.
AMT Exemptions: As part of the AMT computation, taxpayers are allowed an AMT Exemption. This is a fixed amount based upon filing status. As part of Congress’s AMT crutching efforts, since 2001, the exemption amount periodically has been increased for inflation. However, barring Congressional action in 2007, the exemption amount will revert back to pre-2001 levels. Thus, for joint filers, the exemption is set to drop from $62,550 (the 2006 exemption) to $45,000, and for single taxpayers from $42,500 to $33,750.
In a recent report by the Joint Congressional Committee on Taxation, and due primarily to the factors outlined above, it is estimated that the number of taxpayers affected by the AMT in 2007 will increase substantially. As an example, the Committee estimates that the number of taxpayers just in the $75,000 to $100,000 income (AGI) category who will be subject to the AMT will jump from 170,000 taxpayers to 5,700,000 taxpayers, and the additional tax attributed to the AMT for these taxpayers will jump from $290 million to $6.3 billion.
2007 may be the turning point for the AMT, and hopefully, Congress will institute meaningful reform. If you have questions about how you might be affected by the AMT in 2007, please give this office a call.
E Thomas Associates Inc. is a registered investment advisor in Kentucky.
Dave Smith & Tony King are Registered Representatives of and securities are offered through Dalton Strategic Investment Services, Inc., member FINRA & SIPC. 6408 River's Edge Rd, Greenville, OH 45331
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