The alternative minimum tax (AMT) is an add-on that tends to hit upper-middle income taxpayers (roughly $100k to $400k income), especially those with children, living in high tax states, or with long-term capital gains over $10k. This much is general knowledge among tax experts.
However even some tax practitioners may not know that a huge AMT sucker punch is currently set up for tax year 2005, when the AMT exemption drops by $13k (for joint returns) unless both political parties get together on a fix. The prospect of such cooperation is dimming, in my opinion. Therefore as I did last year, I recommend prepaying some of next year's state income taxes this December to limit the damage in case the AMT bomb does indeed go off in 2005. With today's low interest rates, the opportunity cost of such prepayments is minimal.
The idea is to prepay 2004 state and local taxes in 2003 to the extent you can do so without triggering the AMT. Do the same in December 2004. Then in 2005 you can pay less of these taxes to the extent you accelerated payments into 2004. When the $13k hammer falls you will have almost no room (actually you will have exactly $13k less room) for deductible state and local tax payments. Then you have to hope that voters force a permanent AMT fix for 2006 and later. (Such a fix is virtually guaranteed to include a regular tax rate increase.)
If you plan to sell appreciated assets with over $10k of long-term gain, run the AMT numbers before you sell. You will find that these gains add to the AMT problem, especially if they push you into the AMT exemption phase-out range (>$150k gross income for joint returns). This is because in the phase-out range, your AMT marginal rate is 7% higher (25% of the 28% AMT rate) and there is no room for state income tax deductions. When you run the numbers, often you will find it better to pay the state tax on a long-term gain either in the preceding December or the following April.
If you like to accurately project your tax liabilities and you don't want to write your own tax spreadsheet, download the free version of QITC here. Unfortunately you are on your own for state tax computations.
I created another topic for people who don't already know what the AMT is, and therefore would not be curious about an AMT calculator.
I have my own AMT calculator for California for any year from 2001 to 2010, and it shows that in 2005 the AMT will start at about $75k income for homeowners. If you are not paying property tax and if you have fewer than 3 dependents, you are safe up to about $120k (due to the higher regular taxes that you pay). Above $150k the AMT liability skyrockets under most circumstances, reaching several thousand dollars by the time you get to $200k income.
For 2005 I will have accelerated $7k of tax payments and I will be able to defer $5k into 2006, almost entirely negating the $13k drop in the AMT exemption. The tax savings from this strategy exceed $3k. Of course, if Congress acts in time, all this will prove unnecessary: you will likely pay increased taxes, but they won't be called AMT.
This is a real problem. Using H&R Block's AMT calculator I expect a $1,500 AMT liability for 2005+. This year I still have some AMT room, so I prepaid my state taxes by $4k. I called the IRS to find out what the date of record is considered to be for the prepayment. They said it's the date the check was mailed. They told me to keep a photocopy of the check (which should have a date of 2003) and in addition I'm keeping proof of mailing.
Next year, if Congress hasn't acted to fix this problem, I'd like to prepay real estate taxes as well. But my local municipal government tax collector tells me they can't accept prepayments of property taxes. If I send them a check now to prepay 2004 they will send it back. Hopefully I can persuade the mayor to change that policy by Dec. 2004.
<< Thanks for the link. How did you use it to figure your 2005 AMT? Did you just add $13k to your deduction for state and local taxes? >>
I shifted $13k worth of my mortgage interest deductions (deductible for both regular tax and AMT) to home equity interest (deductible for regular tax only) to simulate the effect of a $13k decrease in AMT exemption amount.
ASSOCIATED PRESS The House voted yesterday to spare millions of middle-income families next year from a complicated tax invented in the 1960s to catch rich tax evaders. The force of inflation is pushing more middle-income households into the alternative minimum tax each year. About 3 million individuals and families paid it this year. The House voted 333-89 to prevent the tax from ensnaring 9 million more taxpayers next year and imposing $17.8 billion in extra taxes. "The expected growth in the individual alternative minimum tax is a major problem in the tax code that must be addressed," Treasury Secretary John W. Snow said. The House bill slows the tax's spread into the middle class by keeping the amount of income exempt from the tax at this year's level, $40,250 for individuals and $58,000 for couples. Without action, the exemptions fall back next year to $33,750 for individuals and $45,000 for couples. The bill will not become law until it is passed by the Senate and signed by President Bush. The less-affluent taxpayers stuck with an alternative minimum tax bill often have a combination of factors that work to lower taxes but are ignored in the alternative minimum tax system. These include high state taxes, unreimbursed employee expenses, numerous children or dependent parents. The forms that test for this tax force taxpayers to run through a long series of calculations. Those who reach the end of the calculations and discover they owe the alternative minimum tax also find that the tax cuts passed during the Bush administration have disappeared. Rep. Phil English, Pennsylvania Republican, said the House bill "will ensure that Americans get the benefits of the marriage penalty relief, child credit and other tax relief we have provided during the past three years." "If this bill is not enacted, it will amount to a tax increase on millions of Americans next year," he said. The White House estimates that 9 million more taxpayers can expect to pay the alternative minimum tax next year unless lawmakers act. The Tax Policy Center calculated that as many as 12 million more individuals and families could get hit with the tax if lawmakers extend tax cuts scheduled to expire at the end of the year but do not address the alternative minimum tax. Three tax cuts are to expire at the end of the year. They expanded the bottom tax bracket, reduced the marriage penalty and increased the child tax credit. The House rejected, 228-197, a Democratic fix to the alternative minimum tax that would have exempted every individual earning $125,000 or less and every couple earning $250,000 or less. They argued their solution would not only prevent millions from paying the tax, but also simplify one of the most complicated parts of the tax code.
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