Remember the October surprise? That was back when Ronald Reagan was about to set up shop in the White House. Jimmy Carter, then president, tried and failed to get release of the Iran hostages before the election.
Well, you may not have to wait until October this year, you may get an April surprise. What are we talking about? Just a nasty little trap called the alternative minimum tax.
This bit of mischief already has hit 3 million taxpayers. BusinessWeek magazine, in a recent cover story, set out the details of this booby trap in the federal tax code.
Congress passed this little monster in 1969. It was intended to snare 155 hefty wallet types who had paid no taxes whatsoever.
But, BusinessWeek said, rather than just the evasive affluent, the middle-class and upper-middle-class couples with kids will get blindsided.
William Gale, a tax economist at the Brookings Institution, a Washington think -tank, commented: The cop and the nurse with two kids are going to get nailed.
Escaping this tax wont be easy for many people. You cant change the number of kids you have or how much state tax you pay; those are the most common items that put the AMT into effect.
The triggers are high state and local taxes, big job-related expenses, incentive stock options or some kinds of municipal bond interest. If you are at the upper end in compensationbetween $100,000 and $200,000 annuallyyou will pay close to $3,000 in extra taxes.
Heres what happens when filing time rolls around. First, you do the normal 1040 just as always. Then you do it all again using Form 6251, and many standard deductions dont apply here.
Once you have the amounts owed, you compare the two returns. Whichever one is higher is the one you pay. The overage from the regular tax is your AMT.
The new tax got out of control because it does not consider inflation. The familiar income tax has brackets and personal exemptions for determining how much of your income is taxable and then computing the tax. But with the alternative minimum tax, as incomes rise, it hits more people.
Oh, but we got tax cuts, you say. They just make things worse. They make it more likely you will be paying the AMT.
By the end of the decade, if this stealth tax is not reformed, the Urban-Brookings Tax Policy Center estimates it will strike 33 million taxpayers per year. Thats about one-third of all taxpayers. Nine out of 10 people who earn between $100,000 and $500,000 in 2004 dollars will pay more than 70 percent of those making from $75,000 to $100,000. Ironically, the very rich pay a smaller share of their income to the AMT than the upper middle class.
The AMT requires the use of Form 6251, so complicated a Philadelphia lawyer would tear his hair out. The form has 65 lines and filling it out will require tax software or a professional tax preparer.
At the worst, this tax can eat into income you dont even collect. If you win $300,000 in a lawsuit, for example, and your lawyer gets $100,000 of it, under the normal tax you would pay on the remaining $200,000. But the AMT assesses you on the full amount, and you could pay up to $28,000 tax on money you never saw.
The AMT allows exemptions of $58,000 for a couple or $40,250 if you are single. You would be taxed at 26 percent for the first $175,000 of income and 28 percent over that limit. The IRS gets either the regular income tax or the AMTs bite, whichever is larger.
If that isnt infuriating enough consider that congressmen and senators were well aware of the effects of AMT even as they voted for and hyped Bushs tax cuts.
Back in 1996, internal estimates for Congress revealed each successive tax cut would put more families into paying the AMT, thus reducing the cost of tax cuts and taking back on the one hand some of the benefits offered on the other.
As early as 2001, legislators were counting on billions in new AMT revenue while passing the presidents tax cuts.
It was conscious, said John Buckley, Democratic tax counsel for the House Ways and Means Committee. It was deliberate.
Source: BusinessWeek online.