The Hidden Tax You May Owe -11/18/07

The Hidden Tax You May Owe -11/18/07

Stewart H. Welch III, CFP, AEP
Founder, The Welch Group, LLC

The Hidden Tax You May Owe


“The Hidden Tax You May Owe”


As many as twenty-five million middle income Americans are likely to feel the pain of a hidden tax in 2007.  The Alternative Minimum Tax (AMT) was created in 1969 as a governmental strategy to make certain that a small number of wealthy taxpayers couldn’t avoid paying income taxes by making use of the many tax loop-holes available. Unfortunately, as often happens with governmental plans, what originally looked good on paper, has now turned into a hellish nightmare for “innocent” taxpayers…namely the middle class.  While you probably have heard the term ‘Alternative Minimum Tax’, few people understand what it means or how it might apply to them.  In essence, the Internal Revenue Service requires that you calculate your income taxes twice.  Your first calculation is the traditional way you’ve always done it.  Then, you must recalculate your taxes using the AMT rules.  Whichever calculation results in a higher tax is the one you owe.

Earlier this month, the Democratic led House passed legislation that restricts the number of taxpayers who would be subject to the tax, saving potentially affected taxpayers a total of about $51 billion.  Of course nothing is free and this bill also included higher taxes on investment fund managers, thus insuring that the bill will be resisted by Republicans and President Bush.  Failure to provide this ‘fix’ could cost affected taxpayers as much as $2,000 in additional taxes for 2007.

Here are a few of the ‘tax facts’ that are likely to cause you to be subject to the Alternative Minimum Tax:

  • Incentive stock options exercised during 2007.
  • Large deductions for state and local income.
  • Large amounts of long-term capital gains.
  • Large medical expense deductions.
  • Large property taxes or home equity loan interest.
  • Large write-offs for miscellaneous itemized expenses such as unreimbursed medical expenses.
  • Significant tax-free bond income from certain municipal bonds.

Assuming that our Congressional leaders fail to resolve the AMT problem for 2007, is there anything you can do to reduce the likelihood of becoming subject to the tax?  For individuals, your best moves include maximizing contributions for you and your spouse to tax deductible IRAs, and company 401(k) plans.  You should also review your personal investments for positions where you have losses that you can take this year.  Remember, up to $3,000 of excess losses over gains is fully deductible against ordinary income.  Also, postpone taking gains on securities you hold until 2008.  If you own your own business, consider prepaying 2008 expenses in 2007 and

conversely, postponing receipt of year-end income until early 2008.  The goal is to reduce your adjusted gross income (AGI) which provides a larger AMT exemption plus it reduces your state and local income taxes, which are disallowed when computing the AMT.

The AMT is a complicated tax so if you think there is any chance you’ll be affected by it, your best strategy is to meet with your CPA as soon as possible. That way, you can still do some tax planning before the end of the year.