What is Worse Than Preparing Your Tax Return?
By Ric Edelman
Having to prepare it twice -- solely so you can pay more in taxes
If you haven't been affected in past years by the Alternative Minimum Tax, chances are you soon will.
Congress created the AMT to make sure rich Americans pay a minimum amount of tax, regardless of how many loopholes they tried to use.
Here's how the process works. You prepare your taxes the usual way, claiming deductions, exemptions and credits under the law. But if your income is above a certain amount, you must calculate your taxes a second time, using an alternative method that is designed to make you pay a minimum amount. Hence, the Alternative Minimum Tax.
The law, enacted in 1970, was aimed at the richest of Americans, and indeed only 19,000 people paid taxes under the AMT. But Congress failed to index the AMT rules for inflation, and as a result, millions of Americans now owe the AMT.
How does the AMT cause you to pay more in taxes? It denies or reduces tax deductions for such items as personal exemptions, state and local income taxes, itemized medical expenses, interest on a second mortgage (unless used to improve the house), miscellaneous itemized deductions and capital gains (although there are some exemptions). And, the more you spend on any of these items, the more the AMT will cost you.
Is there a silver lining? Sort of, thanks to something often called the minimum tax credit. To be eligible you must have previously paid the AMT, but not owe the AMT in the year you plan to claim the credit. Here's an example:
Say that last year when computing your taxes using the traditional method, you owed $30,000. Then, when you re-did your taxes using the AMT method, your tax bill rose to $35,000. (In IRS jargon, your AMT bill was $5,000.) Let's further say that this year, using the traditional method, you owe $51,000. However, the AMT version requires only $44,000. You are eligible to reduce your taxes this year by part or all of the $5,000 you paid in AMT taxes last year. As a result, your actual federal income tax liability this year may fall between $46,000 and $51,000. Are you getting all this?
So what should you do? Compute your income tax liability both ways. Since the AMT form — Form 6251 — is complicated, we recommend you hire an Enrolled Agent, CPA or tax attorney. If you insist on using tax software, make sure it will compute your AMT for you. And if you really are a glutton for punishment, go to www.irs.gov and download IRS Form 6251 and the associated instructions and try to fill it out yourself.
By the way, you might lose the ability to claim some or all of your tax credits even if you don't owe the AMT. How can this happen? Say that, before you claim any tax credits, you determine that you owe more under the traditional tax system than under the AMT. Further say that after you claim the credits, you find that your tax under the AMT is higher than the traditional method. Since you can't pay less than the AMT (recall what the M stands for), you could lose the ability to claim the credits even though you're not technically filing under the AMT. That's why you will probably have to file Form 6251 even if you don't owe the AMT but are merely potentially affected by the AMT.
Are you hating this yet? You will. Because even if you don't yet owe the AMT, well, you will.
This material was prepared for informational and/or educational purposes only. Neither Edelman Financial Services LLC nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.