For those in the know, the AMT has become the tax equivalent of the boogeyman. Unfortunately, unlike the object of children's nightmares, this lurking threat is all too real. Calculated alongside ordinary income tax for all households, the AMT erases many standard deductions to which Americans have become accustomed. Taxpayers then must pay whichever tax is higher.
Q. Could you explain the Alternative Minimum Tax (AMT) and what steps I might take to avoid it next year?
While it currently applies to a relatively small subset of American taxpayers, the number of households affected by the tax is poised to balloon over the next several years. For 2004, the Tax Policy Center estimates that 3.4 million Americans paid the tax-at an average of $5,840 per household. By next year, nearly 19 million taxpayers are likely to be subject to the tax, and by 2010 that number is expected to grow to 30 million, barring any change in the law.
While the estimated 3.4 million Americans who paid the alternative tax for 2004 are very aware of the potential consequences of the AMT, the Eaton Vance study showed many investors don't fully understand or appreciate its implications. Yet the potential bite of this tax is made clear by a list of deductions that it disallows:
Targeting the middle class
The AMT is the result of Congressional legislation following a 1969 Treasury report that revealed 155 individuals with an income of $200,000 or higher ($1.2 million or higher in today's dollars) had avoided paying any income tax in 1966. Outrage over this revelation prompted the passage of a tax law that, despite tinkering over the years, lives on as the AMT (Source: U.S. Treasury).