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URL:  http://boards.fool.com/bhm-i-must-point-out-the-mechanics-of-the-amt-25062961.aspx

Subject:  Re: AMT Date:  1/19/2007  10:14 PM
Author:  synchronicity Number:  326915 of 736855

BHM:
I must point out the mechanics of the AMT goes a long way towards what the flat tax advocates (like me) well.... advocate.

The AMT counts most income, eliminates most deductions and applys a fixed rate to the result.


Exactly. I'm always amused by people who A) are vocal proponents of a flat tax who B) raise their voices in protest at AMT. Not you, obviously, but some other people.

However, that may come about because many people (again, not you) don't understand how AMT works.

fleg:
Isn't it the case, however, that qualified dividends and LTCG are included in the AGI that determines whether you pay AMT or not? IOW, if you have a bunch of dividends and LTCGs, they get taxed at 15% themselves, but push regular income into the 26% bracket when it would have been at 15% otherwise?

Sort of. I'll explain more below.

arrete:
Or 28% or 33% when you would have been 25%. That's what getting us in both 2006, but especially 2007 when DH takes his NUA lump sum. I'm not allowed to take any profits this year unless they change the code <g>. Kidding! I'll be careful, though.

Aren't the rates 10% - 15% - 25% - 28% - 33% - 35% ?


You're confusing AMT with the regular tax.

The simple way to think about it is this: the AMT is like a totally different tax system. Imagine that you're filing another tax return, under a totally different set of rules. Those rules work roughly as follows:

1) Most stuff that is classified as "income", including a few things that might not be under the "regular" system (incentive stock options are the major stumbling block for many people, IIRC)
2) Your deductions are much more limited than under the regular system.
3) Instead of the standard deduction/most itemized deduction/personal exemptions, you get One Great Big Exemption.
4) everything above the Great Big Exemption gets taxed at a 26% up to about 175K, and above 175K it gets taxed at a 28% rate. Dividends, capital gains, stuff from REIT's, whatever. Income is income.

The Great Big Exemption gets phased out if your income is high enough, so the effective tax rate is a touch higher than 28% while that happens, (I'm too lazy to calculate exactly what the effective rate would be), but really, it's essentially "add up all your income from wherever, take a few limited deductions, subtract the Great Big Exemption from that, and tax it at 26%-28%."

For most people, the tax yielded by this system is lower than the "regular" tax. But if the tax under this system is higher, than that's your tax instead of the "regular" tax amount.

So, why has AMT become a big deal? A few reasons, not necessarily in any order:

A) most important, the Great Big Exemption wasn't inflation adjusted. For awhile it was high enough that relatively few people would have an AMT amount greater than zero. But as inflation has moved on over the years, the regulaar tax brackets got adjusted upward. In 2007 the Great Big Exemption, if not adjusted by law, will be $45,000 for Married Filing Jointly. If you have a married couple with two kids, they would have a 10.7K standard deduction in '07, plus 13.6K in personal exemptions (3.4*4), or 24.3K. That's standard deduction: itemized could be far greater.

IOW, the Great Big Exemption ain't that great anymore.

B) Reductions in tax rates. Back when the lowest two tax rates were 15% and 28%, a 26% AMT rate would take awhile to catch up to the regular system.

Now the lowest rate is 10%, followed by 15% and 25%. So the spread between AMT rates and regular rates is greater than it used to be. Combine that with the inflation adjustments up of the regular tax tables...

C) Cash out refis/house appreciation.

The most common time when people start itemizing is when they buy a home. Suddenly they have mortgage interest and property taxes to deduct, and since they're above the standard deduction they can count those state taxes, too..

That's great, but under the AMT regime, you can only deduct mortgage interest used to buy, build, or "substantially improve" your home, and can't deduct the taxes at all. For many people property taxes have jumped substantially as their home values have increased. Also, many people have taken advantage of low rates and that strong housing market to do cash out refis. While much of that mortgage interest remains deductible under the regular system, only interest applicable to the "old" mortgage is deductible under AMT (assuming that refi was not used to improve the home, but rather to buy a car or go on vacation or whatever).

So, many people who deduct up the wazoo on Schedule A find most of that not allowed for AMT. Whoops. And it just so happens that those people are often folks who are solidly "middle/upper middle" class, whose house is a substantial chunk of their net worth.

Anyway, that's why AMT is impacting more people. I'm sure there are people on this board who may be hit by AMT for other reasons, but for a lot of people, the factors above are the main drivers.

Hope that helps explain AMT for anyone needing an explanation.

-synchronnicity
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