Middle Class Taxpayers Should Prepare For The Alternative Minimum Tax

A reader sent me a copy of a letter form his accountant warning of the potential tax increase he (and probably you) is facing if Congress  doesn’t pass another “patch” to the alternative minimum tax, or AMT. The way it works is, if your adjusted gross income rises above the AMT rate, once your taxes are calculated, you will be required to do another calculation to see if you will have to pay the higher AMT rate. It’s very confusing, and could be very expensive. As it is, in 2011, the AMT exemption applied to married taxpayers filing jointly making $74,450 or less and single taxpayers making $48,450 or less. If nothing is done, the exemption thresholds will fall to $45,000 and $33,750 respectively. That’s huge.

For some strange reason, this issue is kind of flying under the radar. We’re hearing about the fiscal cliff, and how John Boehner caved and offered to raise taxes on millionaires and take limits off the debt ceiling, but was turned down by the White House. But we aren’t hearing much about the AMT.

The Wall Street Journal covered it late last month.

That means about 28 million more households would owe “very large, unexpected” AMT liability for 2012, according to the IRS, and they would owe the tax on the returns they file in the spring of 2013.

The article also notes that most of the fiscal cliff taxes won’t hit immediately, but this one applies to this year. It will also hit the blue states the hardest.

From a political standpoint, it’s hard to imagine a better formula for sparking a taxpayer revolt than to impose a large, unexpected tax increase with little or no warning.

The impact would be concentrated in more affluent and urbanized states, particularly those with high state and local taxes (the federal deduction for state and local taxes is one of the breaks that frequently pushes people into the AMT). California’s number of AMT filers would go from 685,000 to more than 5.5 million, according to the Congressional Research Service. New York would go from 477,000 to about 3.9 million. New Jersey would go from 265,000 to almost 2.2 million. (Read More)

Forbes also covered the looming AMT disaster, and made it a little more easy to follow.

In short, the AMT works like this:

Step 1: Compute your “regular” tax liability.

Step 2: Compute your “alternative minimum tax” liability.

Step 3: Take a generous pull of scotch/curse loudly

Step 4: Pay the higher of Step 1 and Step 2.

You see, the not-so-brilliant legislators who dreamed up the AMT didn’t bother to index it for inflation. Yesterday’s millionaires are today’s struggling middle class workers.

I don’t know the income of the reader who sent along the letter from his accountant, but it’s estimated he will owe close to $3000 more for 2012 than he did for 2011 if his income and exemptions are close to last year’s numbers.  The Forbes article notes that the AMT rates are 26% and 28% for those with incomes under $200,000. Is that the rate you paid last year? If not, you might want to get out your calculator.