Millions of homeowners hit with unexpected taxes
by Amy Mastin
Mickey Barefield of Augusta, Ga., considers himself a "typical American." Last year at tax time, he placed all of his financial records in a box and took them to an accountant. Barefield, a self-employed maintenance man, and his wife, a physician, earned about $160,000 in 2006. They paid their share of income taxes throughout the year, but Barefield sold some timber from family-owned property, adding revenue to their tax return. They ended up paying more than $10,000 to the Internal Revenue Service due to the alternative minimum tax.
Will you have to pay?
Even if you earn as little as $75,000 a year, you could be hit with AMT. Certain kinds of income, expenses or deductions like those listed below can put you at risk. Check with a tax pro to learn more.
High income, long-term capital gain or qualified dividend income
Tax-exempt interest from private activity bonds
Interest deduction on a home equity loan not used for home improvement
State, local and property tax deductions
Some medical expenses
Miscellaneous itemized deductions
Personal and dependency exemptions
Incentive stock options
"I hate it," Barefield says of the AMT. "People don't realize how much they're being taxed."
Congress enacted the AMT in 1969 to target 155 high-income households with so many tax benefits they owed little or no income tax. But lawmakers have never indexed it for inflation, so Barefield and his wife were among 4 million taxpayers - some earning as little as $75,000 a year - hit by the AMT in 2006 and 32 million expected to have to pay it by 2010. Fortunately, Congress voted three months ago to increase exemptions allowed under the AMT, sparing 23 million Americans $50 billion in additional taxes on their 2007 returns.
The Congressional reprieve is only temporary, however. The year-long patch was a quick fix as legislators wrangle in an election year with how to make up the lost revenue. "Why hold 23 million taxpayers hostage because of the irresponsibility of the minority not willing to pay for this relief?" asks Ways and Means Committee Chairman Charles B. Rangel, D-N.Y.
Democrats wanted Republicans to back a plan imposing new taxes on hedge funds, but the Bush administration strongly opposed it. "The last thing [American taxpayers] or the U.S. economy needs is a tax increase," says Dana Perino, White House press secretary.
Lawmakers have patched the AMT 14 times since 1971, raising the amount of exemptions allowed on individual and joint returns. But it's still not enough, claim some accountants. Charles Kerner, a CPA in New York City, says a number of his clients are subject to the AMT due to high property taxes. And the recent measure to increase the amount of income that is exempt from the tax - from $42,500 to $44,350 for individuals and $62,550 to $66,250 for those filing jointly - will not sufficiently reduce his clients' burden. "Basically, it's the same as last year," he says, as 4 million people are expected to pay AMT again on their 2007 returns.
A remarkable 22 percent of Angie's List members who responded to a Quick Poll have paid the AMT, and 25 percent of those earn $75,000 to $150,000. Amy Davidoff of Indianapolis is among them. The single mother of two teenagers paid about $15,000 to the IRS because of a long-term capital gain on the sale of a business interest. "I'm not a wealthy woman," says the marketing researcher. "I got taxed at a higher rate because of the AMT. I'm doing things to be smart. In fact, I'm doing things the government recommends and paying for it."
Davidoff discussed the issue with her accountant, Jason Crace of Comer, Nowling & Associates. "We decided this was a better time to do it because I had a business loss within the year to offset it," Davidoff says. "The amount (of taxes paid) would only go up if I waited longer."
Household income, along with common deductions such as property, county and state taxes, business expenses and dependents, can make you a victim of the AMT. But there's no simple list of criteria that defines who must pay. While 57 percent of our poll respondents say they had to pay the AMT due to multiple deductions, 15 percent because they own a second home and 38 percent for other reasons, 23 percent simply don't know why they paid the AMT.
"Making the AMT simple is the hardest thing in the world to do," Crace notes. "The higher your property, state and county taxes, the more susceptible you are as these are added back in to AMT taxable income."
"To be viewed as fair, a tax system must be transparent," adds Joseph Walloch of the American Institute of Certified Public Accountants. "Yet the complexity of the AMT is such that many, if not most, taxpayers who owe the AMT don't realize it until they prepare their returns."
Citizens Against Government Waste, a Washington, D.C.-based private, non-partisan, nonprofit organization with more than 1 million members nationwide, is very critical of congressional decisions regarding the tax. "AMT hits a larger share of the middle class every year," says its president, Tom Schatz. "It should be eliminated entirely."
Schatz and his wife, the owner of a property management company, were forced to pay the AMT two years ago. The couple has two children and no significant amount of deductions, but their combined income - his alone was $267,472 in 2006 - lends them to AMT scrutiny. "We feel we're an average family," Schatz says. "We complied with the law and had to turn around and pay several thousand dollars."
Many of those hit hardest by the AMT are those preparing for retirement, accountants say. Gerald Neumaier, a CPA in Fulton, Md., was hired by a couple in their mid-60s who wrote a check to the IRS last year for about $30,000. The electrical engineer and his wife reported extra earnings when his company took an initial public offering and dividends were paid to each of the employees. They normally do their own taxes but went to the accountant days before the April 15 deadline, shocked by their AMT status. Neumaier sympathizes with his clients. "Ordinary people are being affected by the AMT," he says. "People I never expected to pay it.
"The AMT was a good thing for those it was intended to tax," Neumaier continues, "but they just keep increasing the exemption amount when it needs to be adjusted much higher."
His advice? "Try to plan for certain deductions. Shift expenses when you can." Options include not prepaying certain taxes and delaying medical expenses if possible in a high-income year, he explains.
The best advice of all, however, may be Barefield's approach: Put your documents in a box and quickly consult an accountant. In the meantime, Congress is studying the issue in hopes of coming up with a permanent fix for the 2008 tax season.