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by Andrew D. Schwartz, CPA

I recently met with a married couple, and was trying to explain why they owed taxes this year when they got a refund last year.  When we got to page 2 of their 1040, I pointed out that they were hit by the Alternative Minimum Tax (AMT) this year.  Being that we live in Massachusetts, the wife asked me why she and her husband were subject to a tax applicable to same-sex marriages.

What is the AMT?  The AMT was instituted in the late 1960's to ensure that high income taxpayers pay at least a minimum amount of taxes.  Thirty-five years ago, the tax laws were much different then today's tax code.  Back then, the top tax bracket was 70% or higher, and deductions, credits, and other tax breaks were abundant.  As a general rule, only high income taxpayers were hit by this tax.

In recent years, however, more and more taxpayers are finding themselves paying this tax.  Over the years, the top bracket has been cut in half to 35% while the upper limit for each of the tax brackets has increased substantially because of inflation.  Even so, the AMT rates have held steady at 26% and 28%, and the allowable AMT exemption has not been indexed for inflation over this time period.

Calculating the AMT

When preparing your tax return, you're required to calculate your taxes two different ways.  First you calculate your tax the regular way.  And then you calculate your tax based on the AMT rules.  Whichever tax is higher is the one that you pay. 

To calculate the AMT, start with your taxable income, then add back certain items such as your personal exemptions, state and local taxes, real estate taxes, and miscellaneous itemized deductions (which include your unreimbursed professional expenses).  If you're not an itemizer, you must add back your standard deduction as well.

You'll then calculate your allowable AMT exemption.  Here's where the problem arises.  The purpose of the AMT exemption is to limit the chances of middle income taxpayers paying the AMT.  But if you're single and earn more than $112,500, or married and earn more than $150,000, you must begin to phase-out this exemption - increasing the likelihood of your paying this tax.

From what I've seen this winter, married couples who earn more than $175,000, have a couple of kids, and live in a state with high income taxes and/or real estate taxes are almost guaranteed to pay the AMT this year. 

How Can You Reduce the AMT?

Reducing your Adjusted Gross Income (AGI) is one way to minimize the AMT you might end up paying.  Maxing out your 403(b) or 401(k) plan at work reduces your taxable earnings for both taxes.  Taking advantage of other pre-tax benefits through your employer's Flexible Spending Accounts is another way to reduce your AGI.  Most employers allow you to pay your healthcare costs and dependent care expenses with pre-tax dollars. 

Are you self-employed?  If so, contributing to a SEP/IRA, SIMPLE IRA, or Solo 401(k) might reduce the impact of this tax.  And taking your professional expenses directly against your self-employment income on the Schedule C instead of as a miscellaneous itemized deduction ensures that you don't lose any of these deductions to the AMT.

Self-employed individuals can also reduce their AMT by claiming the home office deduction.  That's because the home office deduction reduces your net self-employment earnings, which reduces your AGI.  And while real estate taxes reported as an itemized deduction aren't allowable when calculating the AMT, claiming the home office deduction moves a portion of those taxes against your self-employment income where they are unaffected by this tax.

If you have a sizeable investment portfolio outside of your tax-deferred accounts, consider switching to tax-efficient mutual funds and tax-exempt bonds or bond funds.  By cutting down on your taxable investment earnings, you'll reduce your AGI.

Another way to cut your AMT is by timing when you pay certain expenditures.  Try to pay your real estate taxes, and even state and local income taxes, in years that your income might fall outside the AMT range.

A Flat Tax

As your income rises, the AMT basically becomes a flat tax.  Once your AMT exemption is fully phased out (AGI of $273,500 for single individuals and $382,000 for married couples), you're taxed on your AGI reduced by your mortgage interest and charitable contributions, multiplied by 28%.  I'm not sure this is what Steve Forbes had in mind when he spoke of a flat tax, however.


Should You File for an Extension? 

by Andrew D. Schwartz, CPA

April 15th is just around the corner.  If you won't be able to complete your tax returns by then, don't forget to file Form 4868, Application for Automatic Extension, with the IRS (available at  Keep in mind that when you file for an extension, you're asking for more time to finish your paperwork, not to pay any money that is due. 

If you owe taxes as of April 15th, expect to pay interest and a penalty on the amount due.  The penalty rate varies based on the amount of taxes owed after April 15th:

  • Failure to Pay Penalty:  If you owe less than 10% of your final tax liability and filed for an extension by April 15th, the "failure to pay" penalty runs at 0.5% per month.

  • Failure to File Penalty:  If you don't file an extension request by April 15th, or owe more than 10% of your total tax liability for the year, the "failure to file" penalty runs at 5% per month, up to a maximum of 25% of the taxes owed.

Let's look at an example where you earn $100,000 this year and your tax liability is $20,000.  As long as you end up paying less than $2,000 when you file your tax return later this year, you'll avoid the 5% per month failure to file penalty.  By having 90% of your total tax liability paid in by April 15th, filing an extension provides you with an extra four months to come up with the remaining tax dollars you owe at a relatively low interest rate.

Self-employed individuals might benefit by filing for an extension as well.  That's because you have until the due date of your tax return, including extensions, to fund your retirement accounts for the year.  If you don't have a retirement plan set up yet, that's no problem.  A SEP IRA can be established as late as the extended due date of your return.

By filing a Form 4868 with the IRS, you'll give yourself an additional four months to fund your retirement plan and deduct the contribution made on your prior year's return.  One strategy commonly employed by self-employed individuals is to pay the full amount of taxes due with an extension, and then to fund their retirement plans prior to August 15th.

Keep in mind that an extension does not give you any more time to fund your IRAs and ESAs for 2004.  The due date for these tax-advantaged retirement plans and college savings accounts is April 15th.




Income Taxes

Saving and Investing




  • Personal income tax returns are due 4/15/05

  • Request for automatic extension, Form 4868, due 4/15/05

  • 1st Quarter estimates due 4/15/05

  • Due date for funding your 2004 Roth or Traditional IRA, or Education Savings Account (ESA) is 4/15/05

  • Due date for self-employed individuals to fund their retirement plans is 4/15/05

  • Self-employed individuals who need additional time to fund a retirement plan should file a Form 4868 with the IRS by 4/15/05


2004 & 2005 TAX FACTS
  • For 2004 the standard deduction for a single individual is $4,850 and for a married couple is $9,700. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.
  • For 2004, the personal exemption is $3,100. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  • The maximum earnings subject to social security taxes will be $90,000 for 2005 up from $87,900 in 2004.
  • The standard mileage rate is $.375 per mile for 2004, and will increase to $.405 per mile for 2005. .
  • The maximum annual contribution into a 401(k) plan or a 403(b) plan is $14,000 for 2005.  And if you'll be 50 or older by December 31, 2005, you can contribute an extra $4,000 into your 401(k) or 403(b) account this year.
  • The maximum annual contribution to your IRA is $3,000 for 2004.  And once you turn 50, you can contribute an extra $500 into your IRA this year.  You have until April 15, 2005 to make your 2004 IRA contributions.  For 2005, you can contribute up to $4,000 ($4,500 if 50 or older) into your IRA.


copyright - 2005 - The REPTaxes Network




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