Avoiding Year-End Tax Traps


Alternative Minimum Tax
Last year, Thomas and Gloria Gordon were looking forward to a vacation and making a few home improvements, but Uncle Sam had other plans. Thomas, a psychologist in private practice who also manages an organizational psychology consulting business with his wife, expected that year’s tax bill to be about $46,000. What they ended up paying was closer to $50,000 — an additional $4,000 thanks to a little known “tax trap” called the Alternative Minimum Tax (AMT).

This time around, the Gordons aren’t taking any chances. They are consulting with their tax professional on an end-of-year tax strategy to ensure that they don’t get ensnared in the AMT trap again.

Any accountant will tell you, when it comes to taxes, the Dec. 31 deadline can be as important as April 15. Making the right moves before Dec. 31 can shave thousands off your bill to Uncle Sam. Conversely, failing to act before the New Year can cost you irretrievable tax-cutting opportunities. This year, the stakes are even higher thanks to the passage of the federal Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), the third-largest tax cut in U.S. history, which President Bush signed in May.

Because of the new law’s many attractive tax breaks and various start and “sunset” dates, you might not have another opportunity for similar tax savings in the coming years. Some provisions take full effect immediately and are then phased out over the years. Others disappear from the tax code unless a future law extends their life.

Those extra tax benefits are one reason more middle-income families have a higher chance of owing the AMT this year. The Joint Committee on Taxation estimates that 2.2 million taxpayers will be subject to the AMT in 2003. That’s a 200,000 increase from the number impacted because of the 2001 tax law. The Congressional Research Service reports that by 2010, with inflation and reductions in regular tax, the number of taxpayers affected by the AMT will grow to an estimated 35 million — 33% of all taxpayers. That’s not what was intended.

Congress originally launched the AMT in 1979 to prevent wealthy Americans from taking so many deductions that they wound up paying little to no taxes. “It’s the legacy of an era when tax rates went as high as 70% and the tax code was full of loopholes for the wealthy,” according to Mark Luscombe, CPA, attorney, and principal federal tax analyst for CCH. To counteract those loopholes, the AMT requires taxpayers to add back certain deductions (including state and local income taxes, property taxes, and some medical or investment expenses) and adjustments that are allowed when calculating a taxpayer’s regular taxable income.

If your deductions add up to a disproportionate share of your income, you, like the Gordons, could be hit with the AMT. But you won’t know for sure until you’ve calculated your taxes — twice (first using the regular tax formula and second using the AMT Form 6251). If the result of your AMT return tops your regular tax,


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