Ahhh the lovely Alternative Minimum Tax. For years the government has been putting patches on the AMT so that it ensnares fewer and fewer people, though without the corresponding adjustment in spending, and we once again dance the same dance now that we have set candidates to the two major political parties. Where do each stand on the AMT?

McCain, during the primaries, proposed doing away with the AMT altogether but recently changed his stance from repeal to phase out. Under the phase-out, more than 4 million households would continue to pay the AMT. To be honest, I doubt McCain really meant “appeal” when he was spoke about it because the thing generates so much revenue, $2 trillion over ten years. He likely meant exactly what he’s saying now, “appeal” it for the middle class but keep it for the wealthy.

I sympathize with the wealthy who feel unfairly taxed for the same services, but the money has to come from somewhere and we all have to buy the same things. While it sucks for someone to have half their next dollar taken away from the government, it hurts that person less than it does someone who has far less earning power (that doesn’t make it right, it just makes it more manageable). Plus, rich people don’t riot.

I do think that the government has to reign in its spending (I used to work in defense, I’m aware of some of its excesses) but unfortunately it’s Presidential politics season and it’s far easier to tax a smaller group than reduce benefits for a larger group.

McCain will repeal the AMT. Wait, no … [CNN Money]

The blogosphere is chock full of things you should do at the end of the year, like making donations and saving kittens, but what about those things you shouldn’t be doing? I’ve put my brain on the subject and while I’m not a tax expert, I believe the following list is a good start of things to avoid doing near the end of the year if you want to save yourself a few tax dollars.

1. Don’t Get Married:

The marriage penalty pretty much sucks (but marriage is awesome!) and your filing status for the year is based on your filing status when the year ends, December 31st. It doesn’t matter if you get married 11:59pm on December 31st or 12:01am on January 1st, your filing status is married no matter what. Is the marriage penalty really that bad? Two singles making $70k a year will pay a total of $13,923.75 each in taxes, or $27,847.5 combined. A married couple making $140k a year combined will pay $28,192.50 – $345 more. I don’t know about you but I’d rather put that $345 into my pocket than Uncle Sam’s.

2. Prepaying Taxes & Other Unallowable Deductions under AMT

The Alternative Minimum Tax is an ugly word lots of people have been throwing around lately and it has the potential of taking a positive tax move and turning it into a hugely negative one. Prepaying certain deductible expenses, such as state/local/property taxes, early allows you to take the deduction earlier – that’s a positive tax move. However, if you are subject to the AMT, you aren’t allowed to take those deductions so you face the double whammy of prepaying your taxes (you lose interest on the money in a bank account) plus you get no benefit for doing so (tax deduction).

First determine if you’re subject to AMT (there is no 2007 calculator, I would just use the 2006). If you are, don’t prepay these normally deductible expenses (state and local income taxes and property taxes, un-reimbursed business expenses, child-tax credits, tax-preparation fees, legal fees, home-equity loan interest). If you are, then try to prepay them if you can so they can be applied to your 2007 tax bill, instead of your 2008 tax bill.

3. Don’t Sell Stock – Lower Capital Gains Rates in 2008

If you’re in the 10% or 15% income tax bracket, next year that your long term capital gains tax will fall to 0%, so wait a few more weeks if you’ve been thinking of pulling the plug on an investment.

4. Defer Compensation If You Can

The following moves all fall under the greater heading of deferring compensation because money you earn in December 2007 is taxed on April 2008. Money earned in January 2008 is taxed in April 2009 – a significant difference for such a short delay.

• 4a. Don’t Take That Bonus (Yet): Bonuses are hot but try to push the payment of that year end bonus to the new year and you can push the tax bill to next year also.
• 4b. Don’t Take A Capital Gain (Yet): Much like a bonus, don’t take a capital gain near the end of the year when you can push it to next year. The reasoning is the same – you get your cash in a few weeks and you get the tax bill in over twelve months. If you have a loss this year, you can even use that to reduce your income. (plus, you might be seeing lower tax rates)

This is part of a Money Blog Network group project in which we discuss some great year end money moves, I went against the grain with this one. If you can think of any moves one should avoid at the end of the year or have any thoughts on any of these, please do share them and I’ll add it to the post.

Representative Charles Rangel (D-NY), Chairman of the House’s Ways and Means Committee, unveiled a huge $1 trillion tax cut bill. It’s a bill designed to get everyone talking about it, rather than skirting the issues, though anyone thinking the House will pass it is likely misguided. I read CNN’s overview of it and wanted to share some of my thoughts with you all (and hope you do the same with all of us).

Decrease: Action! Action! AMT Repealed!

The bill would repeal the alternative minimum tax, rather than patch it for another year, and this is the marquee headline of the bill. I personally think a full repeal is foolish, why not adjust it and then index the dollar amounts with inflation? The idea was to stop the wealthy from taking unfair tax breaks, which is something I think should still happen, so why repeal it entirely when you can help the middle class while still keeping with the spirit of AMT?

Ultimately the goal of the bill seems to be to get discussion going on the AMT, so what better way than to just axe it? Most experts believe that another one-year patch will be put on the AMT to help the estimate 800 billion people likely to be affected by it (yes, 800 billion is a totally made up figure, but that number doesn’t actually matter unless you’re one of them!). It’s like putting a band-aid on an infected cut; it’s nice that you’re doing something, but let’s fix it instead of putting it off.

Decrease: Higher Standard Deduction

An increase in the standard deduction of $850 for joint filers and $425 for single filers, which, in theory, actually helps the affluent more than it helps the middle and lower classes. In theory, if you are in a higher tax bracket, you’re taxed at a higher rate. Thus, by increasing the standard deduction, you actually decrease the tax on a higher income earning person. Now, in practice this idea will help the lower income folks because they are more likely to take the standard deduction. As the standard deduction increases, the idea that buying a home is better, for the tax benefits, will become less and less clear.

Decrease: Easier Child Tax Credits

Without getting into the muck of this particular proposal, I think anything that allows more tax credits for families with children is a good thing. With the rising cost of college, two income families, and other children related items, I think we need to be fostering an environment in which children of all economic classes are able to flourish. Now, this puts the onus on the parents to actually spend that money on the children, which may or may not happen.

Increase: 4% Surcharge, $200k+ incomes

And the warm fuzzies end as we get into the part where the reform talks about paying for the first three tax decreases… The idea with this particular piece is that married with $200k+ in AGI and singles with $150k+ in AGI would have a 4% surcharge on the sum above that limit added onto their taxes. For those over half a million, it’s a 4.6% surcharge. This, in combination with a repeal of the AMT, would theoretically result in lower taxes for those making less than half a million.

Everything Else

That ends the provisions that most directly affects most of us, the rest include additional taxes on fund managers and businesses that will impact us indirectly. Anytime you tax businesses, it has the potential to stifle growth (duh! less money on investment) but I think that’s in part fueled by how people, businesses included, don’t like to be taxed more. However, if you look at the tax cuts, they’re really just closing loopholes like accounting magic (valuation of inventories would be affected), corporate tax break loopholes, and empower the IRS to penalize companies dabbling in chicanery. In fact, the bill actually proposes to reduce the top corporate tax rate from 35% to 30.5%.

Summary

Other than the AMT, this bill doesn’t really do much for me from the perspective of real change. So you tweak a few things here, tweak a few things there, why not just clean up the whole million page IRS code and make things easier on everyone? I think every time I see one of these “mother of all tax reform” announcements, I think about how simple life would be if we had a flat ax or consumption based tax.

What are you thoughts? Fire away!

Thanksgiving is over (even though the leftovers are still packed into the fridge), the Happy Holidays are just around the corner, now is the time to make those end of the year tax decisions before you get overcome with all the craziness of the holidays. So, I dove into the archives and saw that last year I wrote a whole bunch of posts related to year-end tax moves that still apply (most of them) to this year, so I thought I’d link to them so I’d know where they were:

• Offsetting Your Stock Gains With Loses & the Wash Rule
• Claiming the Energy Savings Tax Credit – This refers to the tax rebate you can get if you make certain home improvements that increase the energy efficiency of your home.
• Home Office Deduction for Businesses – Started a business this year? I researched everything I could find about home offices.
• Six Great Tax Breaks – Some of which no longer apply, but others do.
• 10 Common Tax Filing Mistakes – It’s a little early for this article but it’s nice to keep this in mind (here are 15 more mistakes to avoid).
• More Tax Deduction Talk – Charitable donations, refinancing points, and education related deductions.
• Deduction Donations – IRS Tax Rules – I take an untrained look at deductions for charitable donations.
• Retirement Savings Credit – If you earn under $25k, give this article a read.
• Understanding Capital Gains and Losses
• Understanding AMT
• Education Credits!

And, if you don’t like taxes, read this argument about how the tax system will collapse in ten years.

Today, as planned, the Presidential Tax Reform Panel offered two final proposals that would simplify our currently bloated tax code yet still collect the same amount of tax revenue. I discussed it a few weeks ago when details of the proposals were leaked and many of the details turned out to be true. Elimination of the AMT and modifications to how mortgage interest can be deducted are the two hot button issues but elimination of the marriage penalty and alteration of investment taxation rules are pretty sizzling as well.

Eliminate AMT:
The Alternative Minimum Tax (AMT) essentially removes some tax deductions from the rich to ensure they pay their fair share, except what defines the rich isn’t inflation adjusted so now lots of people who aren’t considered rich are facing these taxes. (more on AMT)

Change Homeowners Mortgage Tax Break:
I discussed it a few weeks ago but reserved judgment until the hard numbers came out and it doesn’t look very promising. The deduction is replaced with a credit at 15% of interest and the range of home values eligible for that credit is between $227k – $410k. This bodes well for folks in the 15% tax bracket or less (with eligible homes) but not well for everyone else.

Eliminate Marriage Penalty:
This one never made sense in the first place (especially in an egalitarian society of gender equality!) but they just suggested to double everything for married couples compared to singles.

Reducing Investment Taxes:
This one gets a little confused. Proposal 1 only taxes 25% of your investment gains but at your marginal tax rate, which basically means you’ll be taxed between 3.75% and 8.25% on the whole thing. The second proposal says a tax of 15% across all investments.

Retirement and Savings Plan Changes:
All your retirement and savings plans will roll into one of three plans. All work related ones (401k’s, 403b’s, etc.) are Save at Work Accounts. All IRAs are Save for Retirement Accounts. All educational and health related accounts would fall into Save for Family Accounts. At least it simplifies things and might make a few more people save a little more.

Those five are the major items but there are a few others such as simplifying the filing of taxes (creating a 1040 Simple form that fits on a two-sided 4×6 index card), reducing the number of tax brackets, taxing employer health contributions, and some other deduction repeals. Those five items are the major headliners though.

If you’re interested in some light reading, check out the official report.

CNN/Money reported today that the Presidential Tax Reform Panel has recommended two plans of reform for our complicated federal tax code (they met for the second and last time yesterday). The first is to simplify and modify the current federal tax code while the second adds a “progressive” consumption tax; both include the elimination of the much hated and now miss-targeting Alternative Minimum Tax. A few of the suggestions make great sense while others don’t but for the most part I think they’re worth discussing.

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This is the third post a series of Tax Relief advice articles, be sure to read the first one about Deducting State Sales Tax Instead of State Income Tax and the second one about the Alternative Minimum Tax. You can see the whole collection under the category of Tax Relief 101.

If you invest in anything whatsoever, capital gains and losses are a necessary and often misunderstood aspect of your taxes. What differentiates a long term capital gain and a short term capital gain? If I miss on an investment, how can that pain be lessened by gains you’ve had in other investments? What’s this I’ve heard about dividends being taxed at a lower rate? Get your pens and pencils and read on.

Long Term vs. Short Term Gains
If you’ve owned the investment for over 366 days (1 year plus 1 day), then it is taxed as a long term capital gain. If you’ve owned it for less than a year, it’s taxed as a short term capital gain. It’s as simple as that.

Recently, the long term capital gains tax rate was lowered by 5% for every tax bracket (effective until 2008) . Now, the rates are 5, 15, 25, and 28%. If your income is taxed in the 10-15%, your maximum long term capital gain tax is 5%. Everyone else is taxed at the 15%. The 25% rate applies to real estate you’ve sold that you claimed any depreciation on (Section 1250 property). The final 28% category is for small business stock and collectibles.

Short term capital gains? They’re taxed as income for the year! If you’re in the 15% tax bracket, it’ll be taxed at 15% (instead of at 5%). That’s why they say that short term capital gains can eat into your stock profits because of the significantly higher (10% difference) tax rate.

Capital Losses Offsetting Capital Gains
If you make a bad pick (or two or twenty), any losses you sustain can be used to offset any gains you had this year. If you had a particularly bad year and had no gains, up to $3,000 of the losses can be used to offset your other income. If you’ve lost more than $3,000, then you can carry it to the following year. That’s why you hear advice from professionals about selling stocks in which you’re in the red in order to offset the gains you’ve had. One important rule you must understand is the “Wash Rule” which only allows this offset if you do not repurchase the stock within 30 days, otherwise this is thrown out.

Dividends Taxed at 5, 15%
Remember the two tax brackets for gains? Well now dividends are taxed at those rates, 5% for 10-15% taxpayers and 15% for everyone else.

I hope I’ve covered a few of the big concepts of capital gains taxes that give people the most trouble and dispelled some of the misconceptions people carry around. I wouldn’t let capital gains taxes dictate your investment strategy but it’s a very important aspect to always keep in mind.

This is the fourth post a series of Tax Relief advice articles, you can see the whole collection under the category of Tax Relief 101.

If you’re like me, you’ve heard about this ugly Alternative Minimum Tax (AMT) monster that will come and make you pay more taxes. And just like me, you know nothing about it. In this installment of Tax Relief 101, the AMT monster will be explained so you understand why it’s here and what it means for you.

Background: Back in the days of yore, a lot of high-income folks were finding very creative ways to get out of paying as much tax as they were expected to. The government obviously found this very frustrating so they created an alternative set of rules to assess tax liability because they felt that at a certain level of income, you should pay at least a certain amount. The AMT is simply your tax liability calculated by those alternate rules and but it’s starting to apply for more people than before and it’s pissing all those people off.

Basics: When you’re doing your taxes, you’ll arrive at a number which is how much in taxes you will pay for last year. It will be higher than what you wanted to pay. Then, you calculate how much you would pay according to the AMT rules and what you owe is the larger of the two numbers (awesome!). Technically, you pay your regularly-computed tax and then the difference between that and the AMT is considered your AMT.

How To Calculate:
Easy Way: Get some good tax software and it will calculate it for you.
Hard Way: You can compute your AMT using Form 6251 which you can download from IRS.gov. Just get the software.

So basically AMT is Congress’ way of getting you to pay a minimum amount, even if you have completely legal deductions that would reduce your tax liability! Is there anything you can do? No, unless Congress changes the rules. The only good news is that a portion of your AMT can be credited back to you in future years. This is how you do it:
1. Figuring Available Credit – First you need to figure out how much of the AMT you paid the year before is eligible to come back and help you this year. You need to figure how much of the AMT from that year is the result of timing issues, that is anything you did to delay reporting income as opposed to something that just reduced your reportable income. You can use Form 8801 to figure out how much credit is eligible.
2. Figuring How Much Credit You Can Use – Then, after you’ve figured how your regular tax and AMT for this year, you can use any available credit from the prior year to cover the difference between regular tax and AMT if your regular tax is greater!

Example: In 2004, you owe $10,000 in regular tax and $8,000 according to the AMT, thus your tax liability for 2004 is $10,000. You calculate that you have $4,000 in credit from the AMT from 2003. You may use $2,000 of that credit, the difference between regular and AMT, and apply it towards your tax liability of $10,000 so that you only owe $8,000 of tax for 2004.

So basically, high-income people were pushing off their income to be taxed in a later year so Congress created the AMT to capture the tax this year and give them credit next year when they do report it. It’s a interest-free loan from your pocket to the US Government. The downside is that now it’s affecting people without high-incomes who are taking deductions they should be taking.

Ultimately, what this means to you is that you need to do more math (or your tax program/accountant does more math), but at least now you have an inkling as to why you need to do more math.

This article has been made somewhat obsolete for 2006 (2005 tax year). The rules are the same but the documents you reference have changed. See the note at the end of the article.

Welcome to the second article in a series I call Tax Relief 101 designed to help you save some cash from the tax man. You can see the whole collection under the category of Tax Relief 101.

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