One of the best things that can be said about the alternative minimum tax is that Congress was successful in making it difficult to get around this tax. To avoid the AMT, you need to understand how the AMT differs from the regular tax system.
We'll walk through Form 6251, line by line, looking at the way the AMT handles different deductions and expenses, and wherever we see a tax-planning opportunity, we will suggest how to lessen the impact of the AMT.
Line 1, Standard Deduction: If you itemize, this line is the amount shown on line 41 of your 1040, which is your adjusted gross income (AGI) minus your itemized deductions (some of which are added back in on the following lines). If, on the other hand, you take the standard deduction instead, this line is solely your AGI from line 38 of the 1040 because you can't take any part of the standard deduction when calculating the AMT. So, if you took the standard deduction on your regular return, it is effectively added back into your income here.
Also, in calculating the AMT you cannot take the deductions for personal exemptions. Because the amount on line 38 or 41 of the 1040 is used as the starting point for computing the AMT, the personal exemptions (which are claimed on line 43 of the 1040) are effectively added back into your income for AMT purposes. This is one of the reasons that married couples with children are strongly affected by the AMT. If you are a married couple with three children, you lose $17,500 ($3,500 x 5) in personal exemptions under the alternative minimum tax in 2008.
Line 2, Medical Expenses: If you itemize deductions, medical deductions are only allowed to the extent that they exceed 10 percent of adjusted gross income, rather than 7.5 percent under the regular tax system.
Suggestion: If your employer has a pre-tax medical deduction plan or cafeteria plan, sign up for it. You can reduce your salary to pay your medical expenses on a pre-tax basis, which will help you reduce both the AMT and your regular tax.
Line 3, Taxes: In calculating the AMT, you cannot take itemized deductions for state and local income tax, real estate taxes, and personal property taxes, even though these are deductible on your regular return.
Suggestion 1: In a year that you have to pay the AMT, don't bother prepaying real estate or fourth-quarter state estimated tax payments in December. You get no benefit from paying these taxes in a year that you are subject to the AMT.
Suggestion 2: Real estate tax and personal property taxes are not deductible for AMT if they are part of itemized deductions. Taxes deductible on a business schedule (Schedule C), rental schedule (Schedule E), or farm schedule (Schedule F or Form 4835) are allowed for the AMT.
Perhaps you can qualify for a home office, which would allow you to deduct part of your home real estate tax on Schedule C.
If you have a farm operation and use your car in your work, you could deduct the personal property tax on the car on Schedule F.
If you have vacant arable land on which you are paying real estate tax, you could turn it into a farm rental and deduct the taxes on Form 4835.