Fewer Alternative Minimum Tax Victims Expected for 2010

If you were worried that you might fall victim to the alternative minimum tax this year, you may have dodged a bullet. Part of the compromise tax package that President Obama negotiated with congressional Republicans to extend the Bush-era tax cuts for two more years would also raise the AMT exemption amounts above last year’s level. That means if you didn’t pay the AMT in 2009, and your financial situation has remained essentially the same, you probably won’t pay the stealth tax in 2010, either. That assumes Congress approves the tax deal before adjourning for the year.

The AMT is a parallel tax system created in 1969 to make sure that the very wealthy paid at least some tax. But because it was never indexed for inflation, the AMT has morphed from a “class tax” into a “mass tax” over the past four decades. In recent years, Congress has dealt with the problem by passing temporary patches to raise the exemption level one year at a time, shielding more than 20 million middle-class Americans from this parallel tax system, which disallows many popular tax breaks.

The compromise tax package would raise the AMT exemption amounts for 2010 to $47,450 for single filers and $72,450 for married couples filing jointly. Without congressional action, those exemption amounts drop back to $33,750 and $45,000, respectively, for 2010.

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But if Congress doesn’t act before year-end, more than 27 million Americans -- about one-third of all taxpayers -- will find themselves in AMT territory, up from just four million who paid it in 2009.

And knowing whether you’ll be an AMT victim in 2010 could be important when deciding on some of your usual year-end tax moves. The AMT does not allow deductions for state and local taxes, home-equity loan interest (unless the borrowed money was used for home improvements), or tax and investment expenses -- write-offs that save money in the regular tax world. Nor does it allow personal exemptions -- worth $3,650 this year -- for yourself, your spouse and each of your dependent children. Consequently, taxpayers with large families or those who live in high-tax states, such as California and New York, are more likely to find themselves subject to the “stealth tax.”

Normally, if you pay quarterly estimated state income taxes or have a real estate tax bill due in January, you can prepay it in December and boost your deductions on your 2010 federal tax return due next spring. But if you're subject to the AMT, this sooner-than-later strategy won't work for you. (The AMT does, however, permit tax deductions for charitable contributions, so you can go ahead and make your usual year-end donations.)

The top AMT rate is 28%, well below the 35% at which the regular tax maxes out. But because more income can be taxed by the AMT, you could wind up with a bigger tax bill. And -- you guessed it -- the law says you have to pay whichever bill is higher.