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GETTING PERSONAL: AMT Pitfalls Spur Advice For Taxpayers January 9, 2007

Posted by notapundit in Economic News, US News.

NEW YORK (Dow Jones)– The stealth tax is taking more taxpayers by surprise.

Financial advisors and tax preparers are spending more time advising clients on how to deal with the alternative minimum tax. This levy is separate from the regular income tax, and it affects more of the middle class each year, many of whom are surprised when it strikes.

Congress has been grappling with how to reform the AMT, which is also known to tax advisors as the parallel tax, the shadow tax and the stealth tax. Without further action by lawmakers, the AMT will affect some 20 million more people in the 2007 tax year, according to The Tax Policy Center.

Triggers for the AMT are stock options, high property tax, and numerous personal dependents. The tax is notoriously convoluted, so decoding it for taxpayers can be difficult. Advisors say they are increasingly on the alert for red flags in client profiles.

“We’re definitely seeing more use of the AMT, and the interesting thing is how little clients know about it,” said Bill Stone, senior vice president and market investment director of PNC Wealth Management at PNC Financial Service Group Inc. (PNC).

Jackie Perlman, senior tax researcher at H&R Block Inc. (HRB), has also seen the AMT cropping up more. Now is a good time of year to check whether you will have to pay AMT for 2006, Perlman said. H&R Block has a calculator on its Web site that can help determine that.

“It’s not that you can change your 2006 picture too much at this time, but at least you’ll see it’s coming, and you can pay in some extra taxes and not get killed,” said Perlman.

Here’s the easiest way to understand AMT, according to Perlman: Regular federal tax is an income-tax system that determines what kind of income is taxable and what is deductible, while the AMT is an alternative that treats as income some things that aren’t considered income under regular tax. So, some things you get to write off under regular income tax, you can’t write off under the AMT.

The AMT requires that taxes be figured twice, once using AMT rules and once using regular income-tax rules. A person who would pay more under the AMT pays the difference as a surcharge to regular income tax.

Taxpayers in states with high property tax are at risk for AMT, because the tax doesn’t allow state and local tax deductions. So are taxpayers with big families, because the AMT doesn’t allow exemptions for dependents. Stock options are another big trigger, because they can generate capital gains that throw the owner into AMT.

“It’s very difficult to plan for the AMT,” said Don Weigandt, a wealth advisor for JP Morgan Chase & Co.’s (JPM) JPMorgan Private Bank. “And if the reason you’re getting thrown into it is state income tax deductions and personal exemptions, what are you going to do about it? How are you going to reduce your state income tax — are you going to move?”

Congress put the AMT into effect in 1970, with the goal of ensuring that the wealthy pay at least minimal tax. The middle class is feeling the biggest effect, however, as the ranks of AMT payers explodes. In 2006, 3.5 million people were subject to the tax. If Congress doesn’t act, 23.4 million will be affected in 2007, according to The Tax Policy Center.

The number of people caught by the AMT is growing because it wasn’t indexed for inflation. Moreover, the Bush tax cuts of 2001 and 2003 lowered ordinary income tax rates without raising the AMT exemption permanently.

The AMT exemption is used in figuring how much is paid under the tax. In figuring AMT, the taxpayer calculates his taxable AMT income, subtracts the exemption, and applies the AMT rate to the amount left. In 2006, the exemption was $62,550 for married couples and $42,500 for singles. It will fall to $45,000 for married couples, and $33,750 for singles, for 2007 if Congress doesn’t act.

Congress has kept the AMT in check since 2001 by enacting a so-called “patch” each year which has raised the exemption by enough to keep the number of people affected by the AMT roughly constant.

It is widely expected to enact another patch this year. Even if it does, though, another 800,000 will have to pay the AMT, according to Len Burman, director of the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution. That number would be 100,000 if the patch were indexed for inflation, he said.

Taxpayers with income between $75,000 and $100,000 are most at risk of being caught by the AMT this year if Congress doesn’t enact the patch, according to Jeff Rohaly, director of tax modelling at the Tax Policy Center.

Taxpayers should seek help if they think they might be subject to the AMT because conventional tax-planning wisdom is often turned on its head when dealing with the alternative tax.

For example, a common piece of advice under regular income tax is to accelerate deductions and defer income. For investors subject to the AMT, however, the exact opposite is often best. Prepaying state tax isn’t a good idea under the AMT because you can’t get a deduction for state income taxes.

In Weigandt’s practice at JPMorgan, the AMT crops up most often when a client plans to exercise stock options that will generate a big capital gains tax. Often in these cases, a client will be subject to the AMT in one year but not the next.

Different stock options get different tax treatment when exercised, so figuring out how the AMT will come into play is important, said Weigandt. For example, non-qualfied stocks options generate ordinary income, while incentive stock options generate long-term capital gains.

Incentive stock options are one of the biggest AMT triggers that H&R Block has seen lately, according to Perlman. A taxpayer usually doesn’t report anything on regular income when exercising an incentive option, but the profit has to be reported as income under AMT. Exercising a large package of incentive stock options is likely to throw a taxpayer into AMT, said Perlman.

“If your company is offering you ISOs, be aware there are most definitely tax consequences, specifically AMT consequences, and make sure you understand what you’re doing,” said Perlman.

By Arden Dale, Dow Jones Newswires


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