AMT's widening net

The Alternative Minimum Tax was first enacted in 1969.

At that time, public opinion was that many wealthy taxpayers paid very little income tax as the result of preferential types of income or deductions.

In an effort to require taxpayers with high economic income to pay a tax, even if their taxable income was low, the minimum tax, or as it is currently called, the AMT, was created.

The rules for calculating the original minimum tax were different than they are today.

At that time another "add on" tax was calculated and added to a taxpayer's regular tax liability when certain beneficial forms of income, deduction or credit were utilized.

This "add on" tax was applied in an effort to get these wealthy taxpayers, benefiting from special calculations under the tax law, to pay at least some tax hence the name "minimum tax".

In 1986, as a part of the Tax Reform Act, the structure was completely revised to something that more closely resembles the AMT we have today.

At that time, rather than an add-on tax, the AMT was changed to a parallel system.

The computation of the AMT was to be made concurrently with the regular tax computation and whichever tax was higher was the tax that applied.

This is the general method that is used today for calculating the AMT, although the exact computation and the items considered in need of recalculation have changed over the years.

When the AMT was revised in 1986, Congress did us all a disservice by making the computations very difficult to understand and implement.

The AMT calculations are unnecessarily complicated.

The AMT will not apply in most years for most taxpayers, but many computations for AMT must be made in all years, even when it does not apply.

The adjustments between regular tax and AMT include some very obscure items.

These obscure and rare items make reading the definitions and explanations of the AMT difficult.

For example, how many individuals claim a deduction on their 1040 for the amortization of pollution control facilities? Yet, this is an adjustment that is applied.

There are just so many different adjustments to consider.

The tax would be much easier to administer if the adjustments were much fewer in number.

The irrational complexities of the AMT calculations beg for a simple explanation.

If only someone could create an "Idiot's Guide" to the AMT.

This is impossible because the complexities are not something that can be easily broken down into component parts and explained separately, part by part.

If someone were to do this, the idiot's guide would still have to include all of the esoteric and unusual adjustments in order to be a complete explanation.

This guide would be very long indeed! As an alternative, let's attempt here to understand the basics of what the AMT is and when it most commonly applies.

In this way we can more easily discuss why the AMT has had limited application in prior years but is expected to affect many more taxpayers in 2006 and future years.

The first step in calculating the AMT is to calculate Alternative Minimum Taxable Income (AMTI).

This is done by taking regular taxable income and adding or subtracting the differences between items which must be calculated differently for AMT purposes.

As the AMT system is basically a less generous arrangement in terms of allowable deductions, the resulting AMTI figure is usually higher than regular taxable income.

Luckily for taxpayers, a large exemption amount is allowed to be deducted from AMTI before computing the actual base amount to which the flat AMT rates are applied.

In many cases, the exemption amount is high enough ($58,000 for a married couple filing jointly in 2004) that AMTI is reduced sufficiently for the AMT to not apply.

If no AMT is usually paid when the exemption amount can be used in full, then it follows that AMT will be paid when the exemption amount is limited or unavailable.

This is true.

The AMT will usually apply if the exemption amount is phased out because the taxpayer is a high-income taxpayer and the taxpayer has some adjustment items.

The phase out of the exemption begins when income reaches $150,000 and is complete when income reaches $382,000.

At that point, no exemption is allowed.

At this high-income level, with just some modest adjustments, the AMT will apply.

This is because the AMT calls for the application of flat rates to a broader base of income.

Without the exemption amount, the AMT taxable base is quite a bit higher than regular taxable income and the AMT will usually apply.

Most tax professionals expect the AMT to affect more people in 2006 than in prior years for two reasons.

First of all, the AMT exemption amount is scheduled to be reduced.

It will return to the rate in effect for 2001 of only $45,000.

This will cause the AMT to apply to many more taxpayers.

The second reason that the AMT is expected to grow in its application is that the phase-out calculations are not indexed for inflation.

This means that as income increases due to inflationary reasons, more people will be subjected to the rules for high-income taxpayers and their AMT exemption amounts will be phased out.

For several years now there has been speculation that some form of "relief " from the AMT will be enacted before these effects are fully felt.

To be effective legislation, the AMT exemption amount will need to be enhanced substantially and the level of phase out will need to be indexed for inflation.

These changes would be effective revisions that would lower the application of the AMT.

If, however, Congress merely tinkers with the computations of the complicated "adjustment" items, no real progress will be made.

It is rarely the adjustments alone that cause the AMT to apply.

It is much more often the interplay of the adjustments coupled with the phase out of the exemption that causes this higher level of tax to occur.

If no meaningful revisions are made to the current rules governing the AMT,many more people will be affected by the AMT.

At that point, people will be looking for an easy to understand explanation, such as the "Idiot's Guide", which does not exist.

Betsy Marler is a partner specializing in taxation issues for individuals and small businesses at the Reno office of Kafoury, Armstrong & Co, a certified public accounting firm.

She can be reached at 689-9100 or bmarler@kafoury.com.