Congrats, you owe the Alternative Minimum Tax «

    Congrats, you owe the Alternative Minimum Tax

    We are now solidly into 2014, so it’s time to start thinking about your 2013 tax bill. One big question to be answered is whether you will owe the dreaded alternative minimum tax with your 2013 Form 1040. Congress originally cooked up the alternative minimum tax (AMT) to make sure high-income types who take advantage of multiple tax breaks would still owe something to Uncle Sam each year. These days, however, upper-middle-income folks are the most likely AMT victims. Here’s what you need to know.

    AMT basics

    Think of the AMT as a separate tax system with a family resemblance to the more-familiar “regular” federal income tax system. The difference is the AMT system taxes certain types of income that are tax-free under the regular tax system and disallows some regular tax deductions. Also, the maximum AMT rate is “only” 28% versus 39.6% under the regular tax system. Finally, you’re allowed a relatively generous AMT exemption, which is equivalent to a deduction when calculating the AMT. For 2013, the exemption is $80,800 for married joint-filing couples and $51,900 for unmarried folks. Unfortunately, the exemption is phased out when your AMT income gets too high. If your AMT bill exceeds your regular tax bill, you must pay the higher AMT amount.

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    Causes of AMT exposure

    Interacting factors make it difficult to pinpoint precisely who will be hit by the AMT and who won’t. But here are the danger signs.

    •Your income is high enough (say $250,000 or more) that a good part or all of your AMT exemption is phased-out.

    •You have relatively hefty deductions for state and local income and property taxes under the regular tax rules (say $20,000 or more). These deductions are disallowed under the AMT rules.

    •You have a spouse and several kids which translates into four or more personal and dependent exemption deductions under the regular tax rules. These deductions are disallowed under the AMT rules.

    •You exercised one or more in-the-money incentive stock options (ISOs). The so-called bargain element (the difference between the market value of the shares on the exercise date and the ISO exercise price) does not count as income under the regular tax rules, but it does count as income under the AMT rules.

    •You have a significant deduction for home equity mortgage interest. Under the regular tax rules, you can deduct the interest on up to $100,000 of home-equity loans. But under the AMT rules you can only deduct interest on loan balances of up to $100,000 that are used to acquire or improve your first or second residence.

    •You have write-offs for miscellaneous itemized deduction items (such as investment expenses, fees for tax advice and preparation, and unreimbursed employee business expenses) under the regular tax rules. These deductions are disallowed under the AMT rules.

    •You have business depreciation write-offs for personal property assets such as machinery, equipment, computers, furniture, and fixtures used in a sole proprietorship or a partnership, LLC, or S corporation in which you own an interest. These assets must be depreciated over longer periods under the AMT rules, so a portion of your regular tax deductions are disallowed for AMT purposes.

    •You have private activity bond interest which is tax-free under the regular tax rules but taxable under the AMT rules.

    If you have one or more of these exposure items, you should first estimate your regular federal income tax liability. Then estimate your AMT liability by filling out IRS Form 6251 (Alternative Minimum Tax—Individuals). If your AMT bill exceeds your regular tax bill, you will owe the AMT.