Matias:
Be on the lookout for Alternative Minimum Tax
By David B. Matias
Thursday, February 23, 2006
If you live in
Massachusetts, beware of the Alternative Minimum Tax
We have
reached the tax season, when we all dig deep into our piles of bank
statements receipts. It is not a happy ritual for most, unless you
are in the business of doing taxes for other people and even then,
this is a stressful time. Unfortunately, many of us feel helpless in
the notion of a faceless taxman. Perhaps one of the most arcane
pieces of tax legislation is the Alternative Minimum Tax, which is
going to affect many more Massachusetts residents this year than
ever before. Although there is little that you can do to prepare
yourself, it does help to understand how AMT works.
The
Alternative Minimum Tax was created in 1969 to close a number of tax
loopholes. At the time, it was reported that more than 200 people
with incomes of greater than $200,000 paid no tax. Because of public
outrage, the AMT was created. Now fast-forward 37 years, where
inflation has taken a serious bite out of that income. An income
today of $200,000 is equivalent to roughly $32,000 back in 1969, but
the AMT tax is still in place and largely unchanged. There have been
some adjustments for inflation, but not nearly enough to account for
the 620 percent increase in the cost of living since then. AMT
typically sneaks up on middle-income folks with high state income
taxes and two or more children. If you're living in Concord with a
family, then you are likely to fall in this group.
There
is heated debate around AMT reform, with several Web sites and
organizations focused on the topic (Google "AMT reform" for a
sampling). A solution will not be easy, since repealing the AMT
could result in well over $500 billion in lost tax revenue to the
U.S. Government over the next 10 years. Given the current state of
the government's fiscal policy, this would be difficult for the
country to absorb.
The AMT
calculation is relatively simple. The tax is 26 to 28 percent of
your AMT income after a hefty amount of excluded income. If the AMT
tax is greater than your tax under the regular income tax code, than
you pay the higher amount. The trick is in calculating your AMT
income. AMT income eliminates many of the deductions that we have
come to rely upon; all the exemptions for yourself and your family,
interest on a home equity line is not used for home improvements,
and Massachusetts income and real estate taxes are added back into
your AMT income. The list continues, but these are the items most
likely to affect you.
In
addition to losing many important exemptions, AMT adds to your
income some items you would not normally view as income. The most
important addition relates to incentive stock options (ISO). If you
exercise incentive stock options, and choose to hold onto the stock
then you have created additional AMT income, even if you must hold
the stock because of various restrictions. The income is the
difference between value of the stock at the time of the option
exercise and the strike price of the stock option. Even though you
have paid cash to exercise the options and are holding just stock
certificates, AMT taxes you as if you already made a cash
profit.
This
presented a horrific twist for high-flying stocks. During the
dot.com boom, many people exercised such options and held onto the
stock incurring a large AMT tax. Many of these stocks dropped
precipitously, eliminating the tremendous profits from the stock
option. The result was people owing a large tax bill to the IRS but
with no profit to show for it. More than a few people landed in
bankruptcy because of AMT and uninformed choices.
Getting
back to the calculation of our AMT income, the next step is to take
the AMT income and deduct the AMT exemption of either $40,250 for a
single tax payer or $58,000 for a married couple. If you are married
filing separately, the exemption is a measly $29,000. Finally, take
the AMT income after the exemption and multiply by the AMT tax rate
of 26 to 28 percent. If this resulting number is greater than your
regular tax, than you owe the AMT tax amount.
By
living in Massachusetts with a comfortable income, you are facing
the perfect AMT storm. Since AMT is not adjusted for inflation and
all personal exemptions are eliminated along with state income and
real estate taxes deductions, you are highly likely to face AMT in
the near future. My advice is to work with a good accountant and
start the tax preparation early. Because of the added layers of
complexity, a good accountant may be able to find new twists that
can save you down the road.
David
B. Matias, a certified public accountant, is the managing principal
of Vodia Capital in Concord and can be reached at 978-318-0900 or
dmatias@vodiacapital.com.
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