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All About AMT: How a Tax Meant for the Wealthy Could Affect You

The AMT was designed to tax the wealthy, but instead hits the middle classTaxpayers love deductions and credits -- and why not? The deductions and credits in the Tax Code allow you to reduce your taxable income, and the amount of tax due.

But what if you could deduct everything? What if your super-pricey home meant your home mortgage interest deduction was sky high? Or if you got a huge property-tax deduction because of the exorbitant real estate taxes in your posh neighborhood? Or if you could itemize all your pricey miscellaneous expenses related to your high-paying job?At one point, it was possible to be a wealthy taxpayer and take advantage of so many tax breaks in the Tax Code that you actually owed less tax than someone making a fraction of your salary.

In fact, according to The Washington Post, in 1967, 155 taxpayers with incomes over $200,000 did not pay any federal income taxes (indexed for inflation, $200,000 is roughly equivalent to $1.31 million today).

With that in mind, under the Nixon administration, a new tax item was introduced as part of the Tax Reform Act of 1969 to target those high-income households that appeared to benefit from too many tax breaks. It was called the alternative minimum tax (AMT).

Since 1969, the AMT has changed very little. The income threshold is not indexed for inflation, so each year more and more taxpayers are affected. Congress hasn't bothered to fix the problem; instead, it has been pushing through an annual "patch" to up the amount at which the AMT kicks in. 2010 is no exception.

For most of 2010, the income thresholds for AMT were extremely low. Finally, with just a couple of weeks to spare, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 boosted those income levels. Under the new law, for 2010, the exemption amount has increased to $72,450 for married couples filing jointly; $47,450 for individual taxpayers and $36,225 for married couples filing separately.

Generally, you may be subject to the AMT if your taxable income for "regular" tax purposes plus any adjustments and tax preference items results in an amount higher than the AMT exemption amount. If the AMT applies, you must separately figure a second tax by eliminating many deductions and credits. You pay whichever is higher -- the "regular" tax or the AMT.

Key triggers for the AMT include claiming multiple personal exemptions; high state and local taxes, including property tax, income tax and sales tax; interest on second mortgages; extraordinary medical expenses; unusually high miscellaneous itemized deductions; and participation in a tax shelter.

That said, perhaps the most well-known tax item that causes you to be subject to the AMT is related to income, not deductions or credits -- exercising a significant amount of stock options may trigger the AMT. This is an unwelcome trap for taxpayers who might have accepted stock options in lieu of cash; you'll want to take this into account when negotiating employment and compensation agreements.

If your income is above the exemption amount and you think you might be subject to the AMT, complete federal form 6251, Alternative Minimum Tax - Individuals. You can download a copy of the form from the IRS website using the forms and publications list. You can also use the online AMT Assistant.

The complexity of the AMT lends itself to the use of tax preparation software or a tax professional to help you complete your return; it can be a very difficult concept to try and calculate from scratch on a paper return.

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