WASHINGTON -- There's good news and bad news this year regarding the dreaded alternative minimum tax.
First the good news: Exemptions for individuals and married couples go up, meaning less income is subject to the tax. Individuals and heads of households can exempt $2,000 more, for a total of $35,750, and married couples filing jointly can exempt $49,000, or $4,000 more.
Now the bad news: An estimated 1.4 million taxpayers will still find themselves paying more to the Internal Revenue Service because of the tax - and it's only going to get worse in the years ahead.
Originally designed to prevent wealthy taxpayers from using legal loopholes to escape income taxes, the alternative minimum tax now is snaring more and more middle-class taxpayers who have multiple credits and deductions. One reason is that it was never indexed for inflation, so it affects more people as their incomes rise.
"Over the years, many of these shelters have been curbed," said Bob Trinz, an editor at RIA's Federal Taxes Weekly Alert, a leading publication for accountants. "Much of the motivaton for the AMT has fallen away, but the AMT is still here."
The 10-year, $1.35 trillion income tax cut enacted this year will only make the problem worse in the years ahead because minimum tax rates were not reduced. The Joint Committee on Taxation, which provides formal estimates of tax law for Congress, projects that by 2010 about 35 million taxpayers will pay the alternative minimum tax, compared with 17 million before the big tax cut.
The alternative minimum tax is frequently triggered when taxpayers have multiple large deductions. People with large families and those who live in high-tax states are particularly vulnerable, Trinz said.
To determine if the alternative minimum tax comes into play, a taxpayer must first figure regular income tax and then do the AMT version, leaving out many of the credits and deductions that applied the first time.
After adding various tax preference items to a taxpayer's regular income taxes and subtracting the exemption amount, the alternative minimum tax is figured at a flat rate of 26 percent of the first $175,000 and 28 percent above that amount.
If the minimum tax is more than the regular tax, the taxpayer reports the difference as the AMT amount on the tax return.
One problem is that many people may not be aware they owed any alternative minimum tax until they get a notice from the IRS. Details are found in the 1040 form instructions; most tax preparation software will flag it.
Legislation has been introduced in Congress to eliminate the alternative minimum tax, but it carries a big price tag. Trinz said lawmakers could also raise the exemptions, index the income amounts for inflation or allow some common deductions and credits to be taken against the tax.
"Anything would help over the flat structure we have now," he said.