Be Prepared for Alternative Minimum Tax

Many electrical contractors and inspectors probably were not that familiar with the alternative minimum tax (AMT) a few years ago. However, in the past few years things have really changed. Even the name may trigger a lot of speculation. What, exactly, is this tax an “alternative” to? And, what does the word “minimum” mean? Is it the smallest possible tax that can be assessed? If so, who has to pay it?

Here is a little background on the AMT. First, there has been some type of minimum tax ever since 1969. Because many well-off individuals used credits and tax breaks to cut their tax liability to little or nothing, Congress passed laws requiring taxpayers to calculate their tax liability first under the conventional method and then under the AMT method—and then pay whichever tax is higher.

Although the AMT rates of 26 and 28 percent are lower than the top regular tax rates, the AMT rates are levied on a broader income base—one that excludes personal exemptions and many itemized expenses.

For many years, the AMT affected relatively few people, but that has begun to change. The number of people subject to the AMT will shoot up from 1.4 million in 2001 to about 30 million in 2010, according to the Tax Policy Center of the Brookings Institution and the Urban Institute. And if the tax cuts of 2001 and 2003 are extended, this number will climb to almost 40 million by 2014.

What is behind these big jumps?
Consider these two factors:

No adjustment for inflation—Most taxpayers have been shielded from the AMT by its large exemption. But this exemption is not adjusted for inflation, so, as wages and earnings rise each year, more and more people will be subject to the AMT. The exemption amounts for 2006 are:

  • 58,000 if married filing jointly or as a surviving spouse
  • $40,250 if single or a head of household
  • $29,000 if married filing separately

However, barring Congressional action in the last few months of 2006, the basic AMT exemption is scheduled to decrease in 2007 to its prior levels of $45,000 for joint returns and $35,750 for unmarried taxpayers. If these exemption levels were to return, we could see a huge jump in the number of people paying the AMT in 2007.

New tax brackets—In 2003, Congress lowered the tax brackets. These lower brackets, combined with the available exemptions and deductions, mean that many middle- and upper-income taxpayers’ regular taxes will now be lower than the AMT, which means they will have to pay the AMT.

If you are subject to the AMT, you’ll have to deal with more complicated tax returns
Plus, tax planning is more difficult, because you can’t always predict when you will face the AMT; consequently, you could lose valuable tax breaks. For example, if you have a home-equity loan of up to $100,000, your interest is normally deductible under the regular tax calculations. But, if you’re forced to calculate your tax liability using the AMT formula, your home-equity loan may not be deductible, particularly if it’s used for purposes other than home improvement. Years ago selecting a good tax-free bond for my contractors was simple. Most contractors got involved in the bonds that they were working on. Recently some of their favorite projects do not make the best investments because they too can still be subject to AMT. The lesson here is if you are looking at tax-free bonds, make sure that they are not subject to AMT.

See your tax advisor

In October 2006, a presidential tax reform panel recommended eliminating the AMT, but no one can predict if this recommendation will ever become law.

In the meantime, see your tax adviser to determine if you are susceptible to the AMT; and, if so, what you can do about it. If you have a good understanding of how the AMT works, you won’t be surprised when tax time rolls around.

Jesse Abercrombie
Jesse is a financial adviser with 14 years of experience in the industry. He is experienced in working specifically with construction business owners and executives, along with centers of influence, to build customized investment strategies. He also focuses on helping individuals with their financial strategies during life events such as divorce. Jesse works in tandem with CPAs and estate and family law professionals to help service client financial goals and objectives.