Now that the 2006 tax year is over, some Answer Desk readers are beginning to think about pulling together their return. And more and more are getting hit by the dreaded alternative minimum tax (AMT). Joe in Wisconsin wants to know if there's a simple way figure out if you're in the AMT's path.
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How do you know if you are an alternative minimum tax "victim"?
-- Joe E., Green Bay, Wis.
What makes the dreaded alternative minimum tax truly evil is that there is no foolproof way to know ahead of time whether it’s going to bite you. It's not based just an income threshold, and a lot depends on what kind of deductions you plan to claim.
When first introduced in 1970, the AMT was supposed to close “tax loopholes for the rich” —who were then able to shelter income from taxes using a variety of dodges. Most of those shelters were eliminated in the 1986 round of tax reform.
But the AMT, which creates a parallel universe with its own tax rates and rules for deductions, lived on. And the big problem is that the numbers used to describe who was “rich” weren’t indexed to inflation.
As a result, more and more middle-income taxpayers are getting gobbled up by the AMT monster. Unless Congress acts, this tax will hit more than two-thirds of all taxpayers with adjusted gross incomes of $50,000 to $100,000 by 2010, according to a 2005 report by the Congressional Research Office.
Congress has tried to tweak the law to tame the AMT, and some in the new Congress want to try to slay it. (Senate Bill 55, introduced earlier this month, would repeal the AMT starting in 2007.) But for the 2006 tax year, it’s still alive and well and raking in piles of stealth revenues for the government. And that’s the real reason it hasn’t gone away.
With the federal budget already deeply in the red, doing away with the AMT will cost hundreds of billions of dollars — money the government can’t afford without making some serious spending cuts. One estimate by the Congressional Budget Office found that just indexing the AMT to inflation would cost $513 billion over 10 years. If the Bush tax cuts — now set to expire in 2010 — are extended, the cost would be higher.
In the meantime, the IRS has a "simple" tool on their Web site that's supposed to help find out if you’ve been thrown under the oncoming AMT train for 2006.
The site claims this should exercise take "5 or 10 minutes." But before you begin, you have to have your 1040 filled out so you can enter information from that form to the online tool. There are several other forms you need to fill out first, including a Schedule A for any itemized deductions.
The first step lists a bunch of fairly obscure exemptions, deductions or exclusions that automatically make you an AMT suspect — but doesn't necessarily warrant a conviction. The list includes things like "Section 1202 exclusion," "Qualified electric vehicle credit," and "Income from long-term contracts not figured using the percentage-of-completion method." (That last one is worth "5 to 10 minutes" alone just to figure out what it means.)
Unfortunately, the list also includes "Interest paid on a home mortgage NOT used to buy, build or substantially improve your home" — which is one of the most widely available deductions left for most households. If you plan to take this deduction, you go immediately to the AMT Form 6251, do not pass go, and under no circumstances collect $200.
In the end, you pretty much have to do your return and then serve it up to the AMT monster and see if you're a victim.
So about the only ones benefiting from this law are the accountants we have to pay to figure all this out.
Every day the news media have reports that a) the current weather (i.e. hurricanes, ice storms, droughts etc.) b) crime c) traffic congestion d) worker health issues or e) labor disputes are costing the economy "x billions of dollars" a year. Where are these billions going? If you added up all the "costs" to the economy reported by the media and deducted it from the GDP, would we have any economy left?
—Richard A, Irvine, Calif.
The answer is that — often — one person’s cost is another person’ benefit.
When Hurricane Katrina damaged billions of dollars worth of homes, the cost was very real to the owners of the homes and the insurance companies that paid their claims (or should have). But that money is then used to rebuild, providing new business for contractors, Home Depot and drywall manufacturers. And insurance companies don’t lose money forever — or there wouldn’t be any insurance companies. After paying out big claims, the simplest way to make up for that “loss” is to raise rates for future customers.
Some losses — like manufacturing that moves offshore — are “one way” and never get made up, at least in the domestic economy. But if you look, you can often find a gain on the other side of a loss.
If a big, high-cost airline loses money, for example, some of that money went to the bottom line of a lower-cost competitor. An employer that see health costs rising is one side of an equation that shows the health care industry booming. You get the idea.
So far, this winter's weird weather has produced a number of of winners to balance out the losers . On the other hand, if the effects of climate change become more rapid and sever, it's not hard to imagine how the loss side of the ledger could overtake any gains.
At what point is insurance a waste of money? ... Now that my income is decent and debt low, I am thinking of limiting my home insurance to the building, not the contents (which I could replace in a reasonable amount time probably painlessly). My employer has life insurance and disability insurance. I canceled my policies with my agent. Does this thinking make sense?
-- Pat, Albuquerque, N.M.
Sure, it’s called “self-insurance” and lots of companies do this. The main thing is to make sure you have insurance for catastrophic losses: your car gets totaled, your house burns down, you come down with a hugely expensive medical condition. Roughly the same for property insurance: If you can afford to replace something fairly easily, it many not be worth insuring.
Insurance is essentially a bet — the provider is betting you'll pay more in premiums that you cost them in claims. That's why most "extended warranties" are a bad deal; they're profitable for the manufacturer issuing them because the company knows a lot more about the life span of their products than you so. As with all insurance, the house usually knows the odds better than you do.
And most people's insurance needs change faster than they change their policies. When you buy a new car, you may want a very low deductible so if someone hits your fender, you can get it back to looking like new. But once your car starts to become a senior citizen, it's time to raise the deductible — or consider dropping collision insurance altogether.
Life insurance is another product that provides an opportunity for savings. Most families buy term life policies to replace income lost if a wage-earning adult dies. But once the kids are on their own, the need for insurance to support them goes away.
So when you find a policy you think you don't need any more, or figure a away to cut back by raising your deductible, take the money you would have put into premiums and build an “insurance fund” to cover those losses. You’re setting up your own "in-house" insurance policy.
And if you never file a claim against your fund, you get to keep the money.
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