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Do you think that Alternative Minimum Tax (AMT) is only for Incentive Stock Options (ISO) and the wealthy?

You may be subject to the Alternative Minimum Tax (AMT) in 2006, even if you have the same income and deductions as 2005. The current AMT tax rules sunset and return to pre-reform levels, meaning that millions of people will suddenly be subject to AMT next year.

The Alternative Minimum Tax (AMT) is a separate tax system, with its own rates and deduction rules, that sits side-by-side with the main income tax system. Taxpayers must figure their taxes both ways, and pay under whichever system results in the most taxes. AMT has a lower tax rate ( 26?28%), but allows less deductions. AMT was originally passed to keep the rich from avoiding taxes through creative (but legal) accounting however, because AMT rules were not indexed for inflation, every year more and more ordinary taxpayers are becoming subject to AMT.

Will This Affect Me? The Congressional Budget Office estimates that 16.7% of taxpayers with Adjusted Gross Incomes of $100,000 to $200,000 will pay AMT in tax year 2005. For the 2006 tax year, this percentages jumps to 81.1%. In other words, if you earn over $100,000 per year, you most likely will be subject to AMT in 2006, unless Congress changes the law.

What Can I Do to Avoid AMT in 2006? You may not be able to avoid AMT, but you can minimize its affects by taking any deductions in 2005 that would be wasted under the AMT system, in tax year 2006.

The most common deductions affected by AMT:

no standard deduction
no exemptions (e.g., children)
no state, local, or property tax deduction
no miscellaneous itemized deductions (e.g., tax preparer fees)
no mortgage interest deduction if funds are not used to purchase, build, or improve home (e.g., to pay off credit cards, or purchase a car)
medical expense deduction floor raised to 10% AGI (instead of 7.5%)
Incentive Stock Option (ISO) taxed if exercised, even if not sold

Tips for end-of-year 2005, to avoid wasting deductions in 2006:

prepay real estate taxes
prepay miscellaneous itemize deduction items
prepay state/local taxes (see tax preparer) by paying 4th quarter estimates in 2005, or using prepay voucher (if W-2 employee)
prepay medical expenses
use HELOC for home improvements, instead of other purchases
defer income away from 2006 by fully funding retirement plans, IRAs, deferred compensation plans, and health savings accounts

* * please contact your tax preparer before making any tax planning decisions

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this newsletter was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Here are some other year?end tips you may find useful:

Review, archive and purge financial files

Consider selling stock in December, to spread gains over two years (if planning to sell in 2006)

Consider harvesting losses on investments, to offset gains (up to $3000/year against regular income)

Max out retirement plan contributions (perhaps with supplemental contributions)

Contribute to 529 Plan (may pre-pay 5 years of contributions)

Contribute to IRA (up until tax deadline)

Use funds from Flexible Spending Accounts for medical or child care expenses (may have to March 15th, if employer adopted new rules)

Give gifts to others, up to $11,000 per year, per person (no gift tax return required)

Give gifts to charities & maintain receipts or logs, such as through Intuit?s Its Deductible program

Create charity giving plan and/or mission statement for 2006

Review expenditures for 2005 and plan spending for 2006, including funding for infrequent expenditures (car repair, vacation, gifts)

Review savings and investment contributions in 2005 and plan for 2006 contributions

Elizabeth Potts Weinstein, JD, a licensed attorney and Registered Investment Advisor, is the founder of Potts Weinstein Financial Consulting, a financial and estate planning firm, headquartered in San Jose, California. The firm specializes in providing fee-only, hourly financial planning, estate planning, and investment advice for people from all walks of life and income brackets. For more information about Potts Weinstein Financial Consulting, or to subscribe to our monthly eZine `Prosper!`, please visit http://www.pottsweinstein.com.

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