The Ticking Time Bomb of The Alternative Minimum Tax

The income taxes laws have a far reaching impact on us. Many of the expenses and obligations that we incur are done so on the basis of whether or not those expenses and obligations are tax deductible under current tax law. For example, homeowners will often buy larger houses knowing that mortgage interest and property taxes are deductible. Someone may buy a more expensive car using a home equity line of credit knowing that the interest from the home equity line of credit is tax deductible. People are encouraged to give more to charity knowing that charitable contributions are deductible.

But, what if, after incurring these expenses and obligations, many taxpayers discover that they can’t deduct these expenses after all. Can it happen? Yes, it can and it is happening more frequently as more and more taxpayers are finding that they are being caught by a little understood section of the tax code known as the Alternative Minimum Tax(AMT).

In reality, millions of taxpayers are already finding that they are having to pay higher taxes than expected due to the AMT. If you haven’t been hit with the AMT yet, don’t breath a sigh of relief. The Treasury Department estimates that the AMT will affect four million taxpayers in tax year 2005 and close to 20 million taxpayers in 2006.

You may be asking, “What the heck is the AMT and how did something like that get put in the tax code?”

The AMT was started in the late 1960′s to plug tax loopholes that the wealthy were using to avoid having any tax liability when they had certain large tax deductions. The AMT put a limit on those deductions for people who had incomes above a certain level-about $75,000. The problem is, the income levels have never been indexed for inflation and so now middle income taxpayers are being increasingly being hit with the AMT as their incomes rise.

One thing that makes the AMT so bad is that it is a difficult tax to understand and and even more difficult tax to figure out. It’s really difficult to figure out without tax preparation software. Then, to figure the AMT, many deductions that taxpayers can take in figuring the regular income tax are disallowed in figuring the AMT. Some of he disallowed deductions include:

Medical Expense deductions

Home Equity loan interest deductions

Property Tax Deductions

State Income Taxes paid

Standard Deduction for those who don’t itemize

Miscellaneous Deductions, such as deductions for job related expenses

As you can imagine, the loss of these deductions can be quite onerous, sometimes adding many thousands of dollars to a taxpayers tax liability.

The good news is that President Bush’s Tax Advisory Commission has recommended abolishing the AMT for individuals. The problem is, the commission will have to find some way to replace the $1.2 trillion in revenue that will be lost over the next ten years if the AMT is abolished. To replace this revenue the commission is looking at proposals to limit the mortgage interest deduction and limit employer deductions for health care insurance.

The proposed limitations on mortgage interest is sure to bring out the big guns in the real estate industry to oppose any changes in deducting mortgage interest. There are sure to be some interesting fights in Congress over Tax Reform.