The alternative minimum tax (AMT) is affecting a growing percentage of taxpayers. And not in a good way. The tax, which applies to both individuals and corporations, is complicated.
It is important, says Mary Ann Quay, the co-managing partner of Vicenti, Lloyd & Stutzman LLP, to be cognizant of this law.
“People really need to be aware that the possibility is there,” she says. “Without knowing that, you can unwittingly do some things that you think are going to save you taxes but don’t.”
Smart Business spoke with Quay about why the AMT was originally implemented, the difficulty in minimizing this tax and why she doesn’t expect lawmakers to make any radical adjustments to it anytime soon.
Why did Congress originally institute the AMT?
The alternative minimum tax, which was started in 1979, came at a time when tax rates were fairly high. Congress was concerned that there were a number of wealthy taxpayers who were not paying their fair share of taxes by…taking deductions that were allowable and that were generally only available to the wealthy.
Things like depreciation, depletion and high deductions for state income taxes and property taxes that normal people don’t get. There were enough people in the wealthier category who weren’t paying very high taxes. So in order to remedy that situation and get more tax revenue, they passed the alternative minimum tax.
Why are people in the middle-class tax bracket now being hit so hard by this tax?
Over time several things have happened. One is that in 1986, the tax laws changed so there were fewer brackets and the rates went down. As a result, the wealthier taxpayers, and even the people in the middle tax brackets, are not being taxed at as a high a rate on the top side as they used to be.
At the same time, peoples’ incomes have gone up due to inflation and general increases in earnings. So people have higher incomes and the exemption amount, the amount that’s allowed as a deduction for alternative minimum tax purposes, has not been indexed to inflation.
The level at which taxpayers are being hit by the alternative minimum tax has decreased so that middle-income people are now being hit. There are projections that by the year 2010, one-third of all taxpayers will be paying alternative minimum tax.
How can people plan ahead to minimize tax liability?
The way the AMT works is there are two tax calculations that everyone needs to do: the regular tax and the AMT tax. If the AMT is higher, then you pay it. The things that you do to reduce AMT also increase your regular tax. So you really don’t plan to minimize AMT so much as you plan to find the crossover point where your taxes are the lowest they can be and at the same time not lose the deductions that you end up losing with AMT.
What you try to do is make sure that you know whether or not you’re going to be in the AMT situation for the year, and if you are, you defer or put off those types of deductions so you don’t lose them. Hopefully you can put them into the following year so you can use them when you might not be affected by the AMT.
How can a company help to protect its employees from the AMT?
If a company requires employees to pay for certain things on their own like automobiles, computers and travel, the employees do have the ability to deduct those on their tax returns, but they’re usually itemized deductions. If you have a large amount of those, you end up losing them to AMT.
What a company can do to benefit their employees is pay those things for the employee rather than have them pay it directly. Even if you do that, while at the same time reducing wages, the employee comes out better in the long run and it’s the same out-of-pocket total for the company.
How does a small corporation qualify for the AMT exemption?
If they have average earnings in three years prior to the tax year of under $5 million in revenue, then they are exempt from the alternative minimum tax.
What changes do you expect to see in regards to this tax law in the future?
There has been a lot of talk about repealing the AMT, but I don’t think that is going to happen, especially with the budget being like it is. It would be giving up a huge amount of revenue for the government. In fact there are projections that by the year 2008, the AMT is going to be more tax than the regular tax; it would be cheaper to eliminate the regular tax than to eliminate the AMT. So I don’t think it’s going to be eliminated.
Mary Ann Quay is co-managing partner of Vicenti, Lloyd & Stutzman LLP. Reach her at [email protected].
