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The AMT: a “Just” Tax Gone Awry

heroic investing logo and photo”The fruit of the just man is the tree of life, “ says King Solomon in Proverbs 11:30.  For the King, dealing justly in the world is an important part of living in the grace of God and an essential part of living a life guided by wisdom.  Today’s tax laws have striven to create a measure of equity between the wealthy and the – well, not so wealthy – with provisions such as the Alternative Minimum Tax.

The AMT is an old income tax provision which attempted to establish some measure of equity by closing loopholes that allowed the wealthy to avoid paying income taxes. But that measure has been slowly failing, affecting more and more lower-income taxpayers – until it was finally fixed this year. Still, individuals in those marginal tax brackets may still face the AMT on income earned in 2012.

The AMT has been around for a long while. Created in 1960, it originally targeted less than 200 individuals with incomes of over $200,000.  These people, rich by the standards of the times, had been able to avoid paying any federal taxes through a variety of loopholes involving investment income and other kinds of business assets.

But at its inception, the AMT was never adjusted to allow for inflation and the changing value of the dollar.  Without that annual adjustment even a yearly increase of a few percentage points brings more and more taxpayers closer to the line that separates those higher income brackets from most middle and lower class filers.

As of January 2, 2013, with the enactment of the American Taxpayer Relief Act, the AMT was finally permanently indexed for inflation, providing some relief to taxpayers for years to come. But for those filing taxes for 2012 may still have to deal with the AMT in some form, even if only to establish that it doesn’t apply.

Under current conditions, you could owe AMT if your taxable income for 2012 was more than $78,750 for a married couple filing jointly, or for surviving spouses, $50,600 for singles, or just $39, 375 for a married person filing separately. That’s a long way from the original income line for which the tax was intended.

The AMT has its own set of tax rates – 26 and 28 percent – and requires separate calculations and paperwork to establish whether the AMT applies.  Under the AMT, a number of tax breaks are disallowed, many of them obviously related to wealthy individuals: incentive stock options, tax exempt interests on private activity bonds, and depreciation on certain kinds of leased property.

Most individuals in the tax brackets on the margins of the AMT dividing line don’t have to worry about those kinds of deductions. But some common tax breaks claimed by average taxpayers may also be disallowed or reduced under the AMT, such as state or local taxes and a number of miscellaneous itemized deductions.  Medical deductions are still allowed, but at reduced rates.

But some home and property related deductions take the greatest hit under the AMT.  Mortgage interest is still allowed, but home equity loan interest is eligible only if used toward home improvements.  Property taxes can’t be deducted at all under the AMT.  Once these disallowed breaks are added back, it’s likely that most taxpayers falling under AMT guidelines rather than the standard tax schedule will end up paying a higher tax bill.

Although the American Taxpayer Relief Act restores some measure of equity to the AMT for 2013 and beyond, its regulations in their current form can affect investors following Jason Hartman’s recommendations on building wealth from income property, since income from property investments boost them into AMT-vulnerable tax brackets.  To clarify eligibility and get the maximum deductions allowed, it’s wise and prudent, as Solomon would say,  to consult with qualified tax professionals to sort it all out.  (Top Image: Flickr/rrodger)

The Solomon Success Team

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