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What You Need To Know About The AMT In 2008

The alternative minimum tax (AMT) simply won’t go away. Despite annual “patches” by Congress to bump up the exemption amounts, the dreaded AMT will affect millions of taxpayers in 2008 unless more comprehensive tax relief is enacted. Whether that will happen remains to be seen. At this point, the safest approach is to prepare for the worst and hope for the best.

Before we discuss how to confront the lingering AMT problem in 2008, let’s take a step back to see how it works.

The AMT in a nutshell. The AMT operates in a parallel tax universe. After you run the numbers for your regular tax liability, you’re required to work through the complex AMT calculation. You pay whichever of the two taxes is higher.

The starting point for the AMT is your taxable income for regular tax purposes. Then you have to add back certain “tax preference items” that you had originally deducted from income, and make other technical adjustments. We’ll spare you the details, but the list of adjustments is as long as your arm. Some common examples of items treated differently under the AMT are:

  • State and local income taxes
  • Real estate and property taxes
  • Large medical and dental expenses
  • Miscellaneous expenses (subject to a 2%-of-adjusted gross income floor)
  • Deductions for personal exemptions
  • The “bargain element” on incentive stock options (ISOs)
  • Interest from “private activity” municipal bonds

After the necessary adjustments have been made, you subtract a personal exemption amount based on your tax filing status. This is where Congress has provided a small dose of tax relief in recent years.

Higher exemption amounts. The annual exemption amounts have been increased through a series of stopgap moves since they were boosted by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). But the amounts will revert to the low pre-EGTRRA levels in 2008 if Congress fails to take further action.

For example, until a late temporary fix was enacted, it was estimated that an additional 21 million taxpayers would have been snared by the AMT on their 2007 returns. Currently, the lower levels are still scheduled to kick in for 2008 (see chart).

But that’s not the end of the story. The AMT exemption amounts are phased out for high-income taxpayers. The reduction is equal to 25 cents of each dollar of AMT income above $150,000 for joint filers and $112,500 for single filers. And these amounts haven't been adjusted for inflation. As a result, no exemption is available to joint filers with an AMT income over $382,000 and single filers over $273,500.

When the AMT calculation is complete, you apply the AMT rate to the net amount. The AMT rate is 26 percent for the first $175,000 of AMT income and 28 percent for AMT income above $175,000.

What’s ahead in ’08? Unless Congress wipes out the AMT once and for all, high-income taxpayers will face a monumental challenge in 2008. It's best to start planning early to minimize your AMT liability . Make an estimate of where you’ll stand at the end of the year, and if you’re facing a major AMT liability, consider the following steps for reducing the tax.

  • Avoid prepaying state and local taxes. Absent the AMT, that’s a good way to bolster deductions at year-end. But this strategy backfires if you’re subject to the AMT because these taxes aren’t deductible for AMT purposes. Prepay enough for your regular tax liability to equal AMT liability.
  • Shy away from investments in private activity bonds. These are municipal bonds that are used to finance private activities such as certain housing projects and hospitals. Income from these bonds is subject to federal taxes if you pay the AMT. Other municipal bonds are tax-free regardless, so make sure that’s what you have in your portfolio. When evaluating munis, specify “AMT free” bonds.
  • Stagger the exercise of Incentive Stock Options. The “bargain element”—the difference between the option’s fair market value and exercise price—is an AMT tax preference, so time such income carefully. Look to postpone exercising ISOs to 2009.
  • Postpone other extra income that might limit your exemption amount. If you expect to realize a big capital gain from a real estate sale, selling the property on an installment basis will spread out the taxable income over several years. Alternatively, wait until next year to complete the sale and then deal with AMT complications. Better yet, explore the possibility of a tax-free exchange under tax section 1031.
  • Reduce taxable income. This is the starting point for calculating AMT so try utilizing techniques to reduce your taxable income like increasing pre-tax 401(k) contributions or charitable donations.
  • Consider accelerating more income into 2008. This may sound crazy, but if you know you’re going to pay AMT and you’re normally in the 33% or 35% tax bracket, moving up extra income means it would be taxed at 28%, the AMT’s top rate.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.

@2008 Advisor Products Inc. All Rights Reserved.

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