The AMT is something that trips up even seasoned tax professionals. There is no way to give you a real detailed summary of it due to is complicated nature but I will try to give you a little bit of a summary.
The AMT was initially started to nab something like 3,000 of the wealthiest individuals back in the '60's who were not paying any taxes due to their shelters and deductions. Due to the fact that it was never indexed for inflation, over the coming years it will nab upwards of 30 million from what I have read by the year 2010. This hardly qualifies these taxpayers as the wealthiest Americans. Congress is fully aware of this inequity but is reluctant to fix the problem because of the loss of tax revenue during these times of huge budget deficits.
On its most fundamental level, the AMT tax is just another way of computing your tax liability according to different rules that the way you calculate your regular income tax liability. If you are subject to AMT you basically compute your regular income tax liability then compute what your taxes would be using different rules under the AMT tax. You are required to pay whichever amount is higher. With me so far?
What happens under the AMT calculation is that not all income and deductions are treated equally when compared to the regular income tax calculation. In addition the tax rate under AMT is also a flat rate of 28%, instead of graduated rates beginning at 10%.
When you calculate the AMT liability, you don't get the benefit of certain itemized deductions such as state and local taxes, certain types of interest, personal exemptions and certain types of income need to be taxed at higher rates such as capital gains and dividends. So even though you hold stock for more than a year which qualifies the gains for a lower rate under regular income taxes, you now need to recompute it under AMT rules at a higher rate to determine if you in fact benefited from the long term holding period.
The AMT changes tax planning strategies significantly for those who fall into the trap. If you are going to fall into the AMT trap anyway, it may not matter if your gains are short term or long term. Also the standard rule of thumb to accelerate deductions and defer income for regular tax planning strategies could backfire significantly and cause you to throw away deductions if paid in the wrong tax year.
It is therefore imperative that all investors with significant gains that are considering sales and option exercises to see a tax professional before hand to see what impact it is going to have on you. That is if you are going to have significant gains. Gains of a couple of thousand dollars don't require any significant planning because it will in all likelihood not trigger the AMT. The other big thing to remember is don't ever let tax consequences alone determine your investment strategy. Don't give up a great selling opportunity just to postpone taxes that would be due since future stock prices are uncertain. You could end up giving up more dollars in capital gains due to selling at a lower price in the future just to save a few tax dollars.
Hope this helps to shed some light on a very complex issue and I hope it saves a few people some significant money by seeing tax professionals before its too late.
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