Some Considerations When Trying To Avoid AMT

BERLIN – When Congress created the alternative minimum tax, or AMT, in 1969, it was designed to ensure that the wealthiest paid at least some tax by closing tax loopholes and limiting shelters. In fact, it’s called the AMT because of the alternative set of rules for determining the minimum tax wealthy investors must pay.

In the first year, only 20,000 people lost write-offs. However, because the deductions, exemptions and tax brackets used by the AMT are not indexed to inflation (as they are in the standard income tax system), an ever-increasing number of middle-class taxpayers have fallen into the AMT over the decades. This year, if Congress doesn’t put its annual “patch” on the tax to contain the sprawl, the AMT will mean a higher tax bill for 23.4 million Americans —23 percent of all taxpayers.

You arrive at your AMT by adding back into your regular tax calculation certain breaks, such as deductible state and property taxes. Then apply a flat 26 percent to 28 percent, depending on your income. If your regular tax calculation falls below the AMT amount, you have to make up the difference.

But there may be steps you can take to avoid the AMT. For starters, consider steering clear of private-purpose municipal bonds — issued to pay for industrial parks, airports and other private ventures — because you may have to pay AMT, though not regular tax, on the interest.

“Private-purpose munis carry slightly higher yields than other tax-free munis, but avoiding the AMT may be worth the trade-off,” said Christopher Wolfe, Chief Investment Officer for the Private Banking and Investment Group at Merrill Lynch.

Also consider delaying your right to exercise incentive stock options. The profit you make when you exercise an option — the difference between the exercise price of a share and its fair market value — is considered income under AMT rules and gets included in the AMT tax calculation, whereas it’s ignored under standard tax rules.

You’ll only be postponing paying tax, of course, but exercising the options in a year when you have more income will lessen the impact of the AMT, says Scott Cooper, Managing Director with the Private Banking and Investment Group. “If the AMT causes you to lose $50,000 in deductions on $100,000 of income, that’s a 50 percent hit,” he says. “But if your income is $1 million, you’ve lost only 5 percent of total income as a result of the AMT.”

Making changes in your investment portfolio is another way to minimize your AMT liability, though not significantly. Of course, you can also hope that Congress repeals or reduces the AMT — a subject of endless debate on Capitol Hill. Currently, some legislators are proposing a tax bill that would completely do away with the AMT, while others are setting the stage for future AMT reform. Eliminating the AMT, however, will come at a price. Repeal of the tax may result in a loss of $800 billion or more over 10 years, so the government would have to generate that revenue elsewhere — “most likely with higher marginal tax rates for wealthier people and a higher capital gains rate,” says Wolfe.

Even if adjustments to your investment strategy do not keep you from having to pay the AMT, it’s wise to speak with your financial advisor and accountant to ensure that your year-end tax strategy takes the AMT into account. After all, the AMT should never be a surprise come April 15.

(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-9084.)