Briefly Noted

    The Top Seven AMT Triggers

    AMT (alternative minimum tax) should be called the alternative MAXIMUM tax, since it typically means paying more in taxes, not less. Because this year’s temporary relief expires after December 31, 2006, the number of taxpayers affected is expected to swell to over 30 million by 2010. While people earning between $100,000 and $200,000 will be hit hardest, a significant portion of those earning between $75,000 and $100,000 are likely to join the AMT ranks as well.

    There’s no set formula or income cutoff to determine who will be affected by the AMT, but some potential triggers include: income between $75,000 and $500,000, many personal and dependent exemptions (i.e., families), large itemized deductions for state and local taxes (even the standard deduction is lost under AMT), exercise of incentive stock options, income from “private activity” municipal bonds and significant capital gain income. Investors should run their income tax projections using a software package or hire a professional. Since they may find themselves in the AMT one year but not the next, multi-year projections are typically required to plan effectively. Then, follow these steps:

    • Even if your itemized deductions total less than the standard deduction, you may be better off taking the itemized deductions if it means staying out of AMT. This might be the case if you have significant charitable or medical deductions. You’d lose the standard deduction for AMT, but get to keep certain itemized deductions—and come out ahead.
    • When projecting the aftertax cost of a home equity loan or line of credit, run an AMT projection if the loan is used for something besides capital improvements to your principal or secondary residence.
    • Be careful with the timing of long-term capital gains. Long-term gains are taxed at the same rate for both regular and AMT purposes, but the additional capital-gain income could put you over the AMT exemption threshold. Also, state income tax paid on capital gains is not deductible under AMT.
    • Exercise incentive stock options (ISOs) with care if you plan on holding the stock after exercise. Run projections to see if there’s a breakeven point at which you enter AMT territory. You might be able to eliminate the AMT by exercising non-qualifying stock options or disqualifying some of your ISOs in the same year. If you do end up owing the AMT, you may be entitled to an AMT credit in a later year.
    • Watch out for private activity municipal bond interest. Review your current bond and bond mutual funds to see if an appropriate AMT-free alternative might make sense.
    • Check limited partnerships and rental real estate. If you’re involved in passive investment activities like these, especially where asset depreciation is involved, the rules become increasingly complex.
    • Prepare for next year. If you’re in the clear this year, but expect to get hit by the AMT next year, pay your estimated state income or local property taxes by December 31 instead of in January of next year. The same applies in reverse: If you’ve been affected by the AMT this year and won’t get any benefit for itemized deductions for state and local taxes, wait until the first part of next year to pay.

    Source: Schwab Center for Investment Research.