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Middle-class taxpayers caught in tax trap
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This would make the AMT almost as common as the mortgage interest deduction is today. The AMT will be the de facto tax system for households with income between $100,000 and $500,000, 93 percent of which will face the tax.

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The Tax Policy Center's findings also show that the 2001 tax cut has increased the number of people subject to AMT. If the AMT had been indexed when the regular income tax was, and had the 2001 tax cut not been enacted, only about 300,000 households would face the AMT in 2010.

Among those hardest hit by the AMT are married couples and parents. Couples will be more than 20 times as likely as singles to face the AMT in 2010. Because the AMT prohibits deductions for dependents, 85 percent of married couples with two or more children will face the AMT. About 6 million taxpayers will face the AMT in 2010 simply because they have children.

Why don't federal lawmakers repeal the AMT? The short answer is money.

In comparing the AMT and regular tax rates, the Treasury found that if recent tax cuts are extended rather let expire as originally planned, the AMT will increase the amount of tax individuals pay in 2005 by $28 billion, rising to $177 billion in 2014. If the AMT system is unchanged, the Treasury predicts that in just a few years it will be more cost-effective to repeal the regular tax system and leave the AMT in place; the U.S. coffers would get more money that way.

That's right. Left unchecked, this little-known flat tax soon could be driving the country's revenue train.

Falling into AMT land
This year, you could fall into ATM land if your taxable income, combined with certain adjustments and tax preferences, exceeds the following limits in 2006:

  • $62,550 and you are married filing a joint return, or
  • $42,500 and you are filing as single or head of household.
  • $31,275 and you are a married taxpayer filing a separate return.

AMT disallows all standard and many itemized deductions, taxable state and local tax refunds and intangible drilling costs. It also taxes employee incentive stock options when exercised; the regular tax system only taxes when you sell the stock.

In AMT land, you'll take a 26-percent tax hit on your first $175,000 gross income, and pay 28 percent above that.

Most taxpayers who fall into AMT land do so because they have a large number of personal deductions for children or dependent parents, live in a high-tax state, or wind up with more taxable income than expected at year's end, either because of a year-end bonus, capital gains, severance package, or because they exercised incentive stock options.

Tax lawyer Robert Sommers has seen the devastating effect that the AMT has had on Silicon Valley taxpayers with incentive stock options. That's because the AMT taxes you when you exercise your stock option, not when you sell the stock.

Here's an example: You have the option to purchase company stock at $1 a share. If, at the time you exercise it, the share price is at $101; that is not a taxable event under the regular tax laws. But under the AMT, the spread -- the difference between the fair market price and what you paid for the stock -- is considered a tax preference, and thus taxed, let's say at 28 percent, or $28 per share. Now let's say the company stock plummets (think dot-com bust). Your stock drops to $5 a share. The AMT still taxes you at the spread level, $28 per share, more than five times the value of your stock.

 
 
Next page: "No sympathy for this devil."
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