If the Alternative Minimum Tax hasn’t gotten into your pocket yet, it soon may. According to the United States Treasury, 25 million individuals will be impacted by this tax for 2007. The increase in the number of taxpayers affected by this tax is staggering. Only 1.3 million taxpayers were affected in 2000 and only 3.8 million in 2006. Congress will have to act quickly to avert the impact for 2007. While proposals being debated range from a quick patch to a major tax overhaul, compromise will be difficult. All will agree that the AMT has reached far beyond its original intent, but no one will agree on how to replace the revenue generated by this tax.

What is the AMT? The alternative minimum tax is another federal tax system that was originally designed to keep high-income individuals from escaping income tax through the use of exclusions, deductions and credits. It has its own set of rules. The income tax liability is computed twice, once under the regular income tax rules and again under the AMT rules. If the AMT liability is higher, this is the one that is used for determining what is due to the IRS. The AMT tax rate is either 26 percent or 28 percent depending upon the alternative minimum taxable income.

How are the rules different for AMT? First, the taxpayer does not get the standard deduction or a deduction for personal exemptions. Those who itemize deductions lose the deductions for state and local taxes. In addition, the interest deduction on some home equity loans is lost if the loan is not for the purchase or construction of a home or for home improvements. Likewise some miscellaneous itemized deductions may be lost, and only those medical expenses in excess of 10 percent of adjusted gross income are allowed rather than those over 7.5 percent used for determining the regular tax liability. There may be other disallowed deductions and otherwise exempt income that must be taken into account.

For 2006, exemptions from the alternative minimum taxable income were $62,550 for couples filing jointly and $42,500 for unmarried individuals. Unless legislative changes are made before the end of the year, these exemptions will be reduced to $45,000 and $33,750 respectively. At any rate, a taxpayer can lose some or all of his AMT exemption due to a phase out determined by income. While the favorable capital gains rates and qualified dividend tax rates of the regular tax system still apply in the AMT computation, a high income creating a phase out of the exemption can diminish the advantages of these favorable rates.

How can one manage the effects of the AMT? Timing is essential. When in or near the AMT, this is one time to consider deferring paying state and local tax payments and possibly other expenses. Deferring capital gains or otherwise managing when capital gains will be realized might be advisable if the overall level of income creates the phase out of the AMT exemption.

Hopefully this has provided some insight into how the stealth like Alternative Minimum Tax works. Surely there will be some changes to it sometime in the future, but don’t count on any dramatic changes for 2007.

Chuck Caldwell is a Certified Public Accountant and Partner at the firm of Silas Simmons, LLP, in Natchez.