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Who's Afraid of the Alternative Minimum Tax?

Year after year, Congress keeps kicking meaningful income tax reform down the road. Consequently, taxpayers continue to be stuck with an archaic, overly complicated mess that pleases no one -- except perhaps some tax accountants who charge by the hour.

A prime example is the dreaded alternative minimum tax (AMT). Enacted in 1969 to close loopholes tha...t allowed wealthy taxpayers to avoid paying income taxes, the AMT has been tinkered with so much over the years that millions of middle-income taxpayers now get snared as well.

Historically, the biggest issue has been that while regular tax brackets, exemptions and standard deductions were adjusted annually for inflation, those used to calculate the AMT were not. Some years, Congress approved one-time "patches" to the AMT income exemption amount so fewer people had to pay AMT -- usually at the last minute. The Tax Payer Relief Act of 2012 finally made the inflation patch permanent.

Many people never realize they're subject to the AMT until they get a letter from the IRS saying that they owe additional tax -- plus interest and penalties. So it pays to know how the AMT works:

Each year, taxpayers must determine their AMT status. The IRS's AMT Assistant can help you quickly calculate whether you're likely to owe AMT, based on a few simple questions about your income and deductions.

If you're a likely candidate, you must fill out IRS Form 6251 in addition to your regular tax form. (The instructions alone are 13 pages long.) In a nutshell, the difference between your regular tax calculation and the AMT amount will get added to your IRS Form 1040 as additional tax.

Lower-income taxpayers typically escape having to pay AMT, but middle-income people with larger-than-average deductions or certain other tax circumstances sometimes fall prey. Here's why:

Under the regular income tax calculation, you start with your gross income and subtract any allowable credits and deductions, eventually arriving at the amount of tax owed. When calculating the AMT, however, many of the usual deductions and exemptions are adjusted downward or completely disallowed, resulting in a higher taxable income.

Deductions that aren't allowed in the AMT calculation include:

•Personal exemptions for yourself, spouse and dependents.

•The standard deduction (claimed by those who don't itemize deductions).

•State and local income, sales and property taxes.

•Miscellaneous itemized deductions (those that add up to more than 2 percent of your adjusted gross income, such as unreimbursed employee expenses, tax preparation fees and many investment expenses.)

•Interest on second mortgages; however, primary mortgage interest can be deducted.

•(Note: The medical/dental expense deduction is more limited than under regular income tax.)

Other items that may trigger the AMT include exercising large stock options (unless you sell the stock within the same year) and large, long-term capital gains. Usually no single item triggers the AMT, but the right combination of factors often will -- for example, if you pay high state and local taxes, claim numerous personal exemptions for dependents and have unusually large itemized deductions.

Back to Form 6251: You'll be asked to perform a series of calculations to determine your AMT income. From that amount you subtract the AMT exemption. For 2013, the AMT exemption amounts are:

•$51,900 for single and head of household filers

•$80,800 for married couples filing jointly

•$40,400 for married filing separately

After several additional calculations, you finally arrive at how much, if any, AMT you owe. The AMT tax rate is 26 percent for AMT income at or below $89,750 for married, filing separately status ($179,500 for any other filing status), or 28 percent for amounts over those thresholds. The resulting amount is then added to your regular income tax owed.

Whew, that's a lot of number crunching. Small wonder many people hire a tax professional to help. Most tax-preparation software will also calculate AMT for you. Just make sure that if you had an AMT capital loss in a previous year's return (say from poorly performing stocks you sold), you carry the loss forward for this year's calculation to offset any capital gains subject to AMT -- the software may not know to do that if it doesn't have access to previous returns.

Bottom line: The good news is that the AMT is now gauged to inflation, so millions more middle-income Americans won't get thrown into the pool, as was threatened last year; the bad news is that until the government finally overhauls our tax system, AMT won't be going away.

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