How AMT confuses taxpayers

WSJ Tax article
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How AMT Confuses Taxpayers

AUGUST 13, 2008

By TOM HERMAN

If you’re confused by the alternative minimum tax, you have lots of company.

A new Treasury Department report says about 226,000 federal income-tax returns filed in 2006 either failed to include the AMT when it apparently should have been or contained “discrepancies” in calculating the amount of the tax. The report, issued by the Treasury Inspector General for Tax Administration, also found a few cases in which the Internal Revenue Service itself made errors.

Of those 226,000 returns, about 165,000 showed differences between what taxpayers thought they owed and what the IRS later calculated they owed, says the report. The other 61,000 returns appeared to owe more tax because of the AMT but didn’t include it.
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The AMT, originally designed to make sure a small number of high-income Americans pay at least some federal income tax, has become one of the biggest and most tangled tax-law webs ever devised by Congress. Last year, the tax ensnared an estimated four million taxpayers, up from about 1.1 million in 2001. Unless Congress changes the law, the number of AMT victims will soar to more than 26 million this year, the Treasury Department estimates.

One reason many people may assume they don’t have to worry about the AMT is that they’d heard it was originally aimed only at the rich. True enough. But the tax has expanded rapidly, especially over the past decade, and now is hitting many not-so-wealthy people, too — often much to their amazement.

“Many people discover they’re in the AMT only after they’ve filed and later get a notice” from the IRS informing them they hadn’t paid enough because they neglected to calculate their AMT liability, says Len Burman, director of the Urban-Brookings Tax Policy Center and a former Treasury official.

Even if you’ve done your own return for years, the AMT can be surprisingly deep water. “I would guess virtually all of these errors are inadvertent and reflect taxpayer confusion and ignorance about their requirement to pay AMT or how to compute it,” says Eric Toder, a former IRS director of research and now a senior fellow at the Urban Institute. Mr. Toder also says the number of taxpayer errors could grow much larger if Congress fails to curb the AMT’s rapid growth.
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Congress is expected to approve a stopgap measure this year, known in Washington parlance as a “patch,” designed to prevent the number of AMT victims from soaring. The Bush administration and influential members of both political parties agree on the need for some kind of temporary solution. But nobody knows when Congress will act or precisely what it will do.

Speculation is growing that Congress may even wait until after the elections, in a special “lame duck” session, to act on this issue and also to resurrect several popular tax breaks that expired at the end of last year. Among those breaks is the option to deduct state and local sales taxes, instead of state and local income taxes, on federal returns.

The AMT operates under many different rules than the regular tax system. For example, it has different allowable deductions, credits and other items. For example, some popular deductions allowed under the regular system, such as state and local taxes, aren’t permitted under the AMT. Among those taxpayers most likely to be affected by the AMT are large families who live in high-tax areas, such as New York City, Washington, D.C., California and New Jersey, and whose income ranges between $100,000 and $500,000.

Winslow Marston, a retired bond analyst who lives in Morristown, N.J., was one of those who were surprised by the AMT last year. “I am one of the poor little schlemiels who is now trapped by the AMT,” he says. He assumes the main reason was his family’s high New Jersey taxes. “This part of the tax code strikes me as not only illogical, but even unconstitutional,” he says. “Basically, it makes no sense to tax people more who already are paying more taxes at the state level.”

The Treasury report urges the IRS to provide information to its examiners reiterating the importance of correctly resolving AMT discrepancies and highlighting specific issues that could lead “incorrect resolution.” The IRS said it agrees and will do so late this year.

One way to avoid an AMT-related mistake on your return is to use tax-preparation software, such as Intuit Inc.’s TurboTax. That can help alert you to whether you’re subject to the AMT and do the number-crunching for you.

A web site offers help to investors who may benefit from a recent IRS courtroom defeat.

Many insurance companies that once were owned by their policyholders converted years ago into publicly traded companies, a process known as “demutualization.” The IRS said the shares that policyholders received in the process had a tax cost of zero. Last week, the U.S. Court of Federal Claims disagreed. For a copy of the opinion and background on the topic, go to http://www.demutualization.biz. This site was set up by Charles D. Ulrich, a Baxter, Minn., certified public accountant who has long argued the IRS was wrong.

A Justice Department spokesman says “no determination has been made as yet” on whether to appeal the decision.
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About Jorge Costales

- Cuban Exile [veni] - Raised in Miami [vidi] - American Citizen [vici]
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