As Americans calculate what they'll owe come tax time, a growing number of them are finding their bill is bigger than they'd expected — courtesy of the alternative minimum tax, or AMT.
Taxes aren't due for another several months, but congressional lawmakers have been busy trying to make sure the 2007 tax season doesn't turn into a major – and expensive – nightmare for those trying to calculate what they owe.
Lawmakers are once again trying to patch a problem with the alternative minimum tax, or AMT, before they adjourn for the year. If Congress doesn't pass a fix soon, the AMT could hit 20 million more taxpayers than it did last year, and millions of others could have their refunds delayed.
While previous fixes to the AMT have spared many taxpayers from paying higher tax bills, it still a term that strikes fear in the heart of many a taxpayer. But just what is it? Here, a primer:
What is the alternative minimum tax?
The alternative minimum tax (AMT) was first enacted in 1969 to make sure that very wealthy people paid at least some income tax. Basically, it's a parallel tax system that is triggered when people with high incomes also claim a lot of deductions.
If the amount an individual owes under the regular tax system is lower than the amount he or she would owe under the parallel AMT system, then the taxpayer must pay the AMT instead. The goal was to make sure that high-income individuals didn't use tax shelters, deductions and loopholes to avoid paying any income tax at all.
Who has to pay the AMT?
Though it started out as a "tax for the rich," the AMT affects more and more taxpayers each year, because the AMT is not indexed to inflation. An income that qualified someone as wealthy in 1969 — say, $100,000 a year — is considered just upper-middle class in 2007, but it could still be enough to trigger the tax.
The AMT often affects individuals with incomes starting around $115,000 a year, and married couples with a joint income of $150,000, says Kate Fries, a financial adviser at the Family Firm in Bethesda, Md. But individuals with lower incomes and various deductions can also be hit.
Under this alternative tax system, taxpayers can't claim deductions for property taxes, state and local taxes, and dependent children. So the AMT has a significant impact on families with children and on taxpayers who have high state and local taxes.
According to estimates from the Tax Policy Center, a Washington, D.C., think tank, if Congress doesn't change the law, 36 percent of married filers with incomes between $75,000 and $100,000 will be hit by the AMT.
How many people does it affect?
The Tax Policy Center estimates that almost 24 million taxpayers will be subject to the AMT for 2007 unless Congress acts to change current law. That's up from the less than 4 million who paid AMT last year, when a temporary, higher exemption was in place.
In 1970, only 20,000 taxpayers were subject to the AMT. If no changes are made, the center estimates that about 39 million taxpayers will have to pay the AMT in 2017.
How can you find out if the AMT will affect you?
Fries suggests that people start thinking about the AMT if they have a yearly income of $100,000 or more. She warns, however, that the AMT can affect taxpayers who earn less than that. And large capital gains — from, say, selling stocks at a profit — can also push an individual into the AMT for a year, even if his or her average yearly income does not.
Calculating whether you'll have to pay AMT can be notoriously complicated. Fries notes that most computer tax programs will run these calculations for you, as will a CPA. But, she says, nobody should try to figure out if they owe AMT using pen and paper forms.
Taxpayers in high-tax states – such as New Jersey, New York, Connecticut, California and the District of Columbia — are more likely to owe AMT than others.
What should you do if AMT does apply to you, or if you think it might?
There's really not much you can do about it, according to Fries. But if you know you'll have a large capital gain, or some other unusual financial circumstance, consult an accountant early.
Another way to lower AMT is to reduce income, by making charitable contributions or by contributing more to a 401(k) or individual retirement account.
Will there be another patch next year?
Passing the AMT patch has become routine for congressional lawmakers, who for years have said that a more permanent fix to the system is also needed. The biggest obstacle to reform is the price tag: repealing the AMT would cost the federal government about $1.7 trillion in lost revenues.