BERLIN – When Congress created the alternative minimum tax, or AMT, in 1969, it was designed to ensure that the wealthiest paid at least some tax by closing tax loopholes and limiting shelters. In fact, it’s called the AMT because of the alternative set of rules for determining the minimum tax wealthy investors must pay.
In the first year, only 20,000 people lost write-offs. However, because the deductions, exemptions and tax brackets used by the AMT are not indexed to inflation (as they are in the standard income tax system), an ever-increasing number of middle-class taxpayers have fallen into the AMT over the decades. The AMT has meant a higher tax bill for 23 percent of all taxpayers.
You arrive at your AMT by adding back into your regular tax calculation certain breaks, such as deductible state and property taxes. Then apply a flat 26 percent to 28 percent, depending on your income. If your regular tax calculation falls below the AMT amount, you have to make up the difference.
But there may be steps you can take to avoid the AMT. For starters, consider steering clear of private-purpose municipal bonds — issued to pay for industrial parks, airports and other private ventures — because you may have to pay AMT, though not regular tax, on the interest.
Also consider delaying your right to exercise incentive stock options. The profit you make when you exercise an option — the difference between the exercise price of a share and its fair market value — is considered income under AMT rules and gets included in the AMT tax calculation, whereas it’s ignored under standard tax rules.
You’ll only be postponing paying tax, of course, but exercising the options in a year when you have more income will lessen the impact of the AMT.
Making changes in your investment portfolio is another way to minimize your AMT liability, though not significantly. Of course, you can also hope that Congress repeals or reduces the AMT — a subject of endless debate on Capitol Hill. Currently, some legislators are proposing a tax bill that would completely do away with the AMT, while others are setting the stage for future AMT reform.
Even if adjustments to your investment strategy do not keep you from having to pay the AMT, it’s wise to speak with your financial advisor and accountant to ensure that your year-end tax strategy takes the AMT into account.
(The writer is a Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)