Unexpected results: AMT and more.

The following scenarios expose some profound inequities imposed by the AMT and other provisions of the 2003 tax law inflicted on unsuspecting middle-class taxpayers.

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SCENARIO 7: Yolanda's Law Suit

Yolanda received an award from a large firm as a result of a discrimination case in 2003. She reported her $135,000 award on her W-2. Her legal fees were a hefty $60,000 and were included in her Schedule A. The AMT robbed her of her entire deduction. After paying her income taxes and her legal fees, she netted less than $30,000. The new law in 2003 saved her $1,170, and she did not benefit from the decrease in the tax rates.

This example demonstrates how the AMT penalizes taxpayers who pay legal fees in connection with awards and judgments.

A FEW OBSERVATIONS

1. Upper-income taxpayers whose income includes dividends can save as much as 23.6 percent over the old law on dividends. They also save 5 percent on long-term capital gains.

2. Upper-income taxpayers whose incomes are not subject to the AMT and whose only income is ordinary; i.e., wages, pensions, etc., can save between 2 percent and 3.6 percent depending on their income levels.

RECOMMENDATIONS

1. Congress should work on AMT reform immediately. The AMT is a predator of the middle class and small businesses. It is robbing them of the benefits granted by Congress.

2. All tax brackets and phase outs should be proportionately the same for all taxpayers. In other words, two single individuals should pay the same amount of taxes as one married couple. A widow(er) with four children and earning the same amount as a married couple should not lose the child tax credit. SCENARIO 1: Phil and Josie Married Phil and Josie own their own businesses, and they have two children. Their income, exemptions, deductions and tax liability for 2003 are as follows: Income Phil's W-2 $120,128 Josie's W-2 50,000

Total Income $170,128 Interest and Short Term Capital Gains 13,928 Long Term Capital Gains 90,239 Business Losses (34,028)

Adjusted Gross Income 240,267 Deductions/Exemptions Taxes (Income and Real Estate) $40,520 Mortgage Interest 12,200 Charitable Contributions 12,400 Limitation (3,023) Exemptions (adjusted for high income) 9,028

Total Deductions/Exemptions 72,125

Taxable Income $169,142 Tax Result Regular Tax $26,882 Alternative Minimum Tax 9,053

Total Tax $35,935 Bottom Line: Phil and Josie's tax liability is $35,935. (You will have to trust our calculation.) Their savings of $6,852 under the new law resulted from a decrease of 5 percent in the capital gains tax and 26 percent of $9,000 (the increase in the AMT deduction.) Since their tax was based on the AMT calcualtion, the decrease in the tax bracket was meaningless for them. Furthermore, their high income means they will not receive a child tax credit. SCENARIO 2: Phil and Josie Divorced Phil and Josie got a divorce. Using the exact same income and deductions from Scenario 1, we will demonstrate the impact of the AMT marriage penalty. Taxes for Phil (Single) and Josie (Head of Household)

Phil Josie Regular Tax $19,625 $4,787 AMT 1,813 - Child Tax Credit 0 (350)

Total Tax $21,438 $4,437 $25,875 AMT Marriage Penalty Phil and Josie married, filing joint $35,935 Phil and Josie divorced -25,875

AMT Marriage Penalty $10,060 Bottom Line: Phil and Josie paid $10,600 more in taxes as a married couple. SCENARIO 3: Linda and Mike Married Linda is an administrative assistant and Mike pumps gas. Two of their four children are under age 17. Their income, deductions and tax liability are as follows: Income Mike's W-2 $50,000 Linda's W-2 50,000

Total Income $100,000 Deductions/Exemptions Taxes (Income and Real Estate) $14,000 Mortgage Interest 7,000 Charitable Contributions 1,000 Miscellaneous 4,000 Exemptions (6) 18,300

Total Deductions/Exemptions 44,300

Taxable Income $55,700 Tax Calculation Regular Tax $7,655 Alternative Minimum Tax 1,185 Less: Child Tax Credit (2,000)

Total Tax $6,840 Bottom Line: Under the new tax law, Linda and Mike save about $1,500 due to the increase in the AMT limitation. They do not benefit from the decrease in tax rates. SCENARIO 4: Linda and Mike on Their Own. Linda and Mike divorced in 2003. Each is the custodial parent for two children and provides for their support. Linda's dependents are under age 17. Filing as Head of Household, their income, deductions and tax liability are as follows: Income Salary (for one) $50,000 Less: Deductions/Exemptions (22,150)

Taxable Income (for each) $27,850

Mike Linda (Total) Regular Tax $3,678 $3,678 $7,356 Child Tax Credit 0 (2,000) (2,000) Total Tax Divorced $5,356 Total Tax Married $6,840 Bottom Line: Under the new law, because they are divorced, they pay $1,484 less than if they were married. By splitting their income, they avoided the AMT. SCENARIO 5: Scott and Lisa Let's assume that Scott and Lisa generated the same income, exemptions and deductions as Mike and Linda (Scenario 3) with one adjustment. In this scenario, we will make the W-2 income $90,000 and include dividends of $10,000. The results for Scenarios 5 and 6 follow: Income Salaries for Scott and Lisa $90,000 Dividends 10,000

Adjusted Gross Income $100,000 Deductions/Exemptions Taxes $14,000 Mortgage Interest 7,000 Charitable Contributions 1,000 Miscellaneous 4,000 Exemptions (6) 18,300

Total Deductions/Exemptions (44,300)

Taxable Income $55,700 Tax Calculation Regular Tax $6,655 AMT 85 Less: Child Tax Credit (2,000)

Total Tax $4,740 Unexpected Results: Mike and Linda's tax with $100,000 AGI is $6,840 while Scott and Lisa's tax with the same AGI is $4,740--a difference of $2,100. The difference is due to the composition of income: wages only (Mike and Linda) vs. dividends and wages (Scott and Lisa). SCENARIO 6: Lisa on Her Own Lisa is the custodial parent for her four children. We will assume her income and deductions are the same as in the previous example. Lisa's Tax Calculation Wages $90,000 Dividends 10,000

AGI $100,000

Less Deductions/Exemptions (41,250) Taxable Income $58,750 Regular Tax $9,383 AMT 2,972 Child Tax Credit (adjusted for high income) (750)

Lisa's Tax as Head of Household 11,605

Net Tax if Lisa were married with same (4,740)

income

Difference $6,865 Bottom Line: Lisa's tax of $11,605 is $6,865 higher than when she was married.

William Stevenson, EA

William Stevenson, EA, president of Long Island based National Tax Consultants, Inc. (ntcstevenson@msn.com) has served as Chairman of NSA's Federal Taxation Committee since 1999. He wants to thank Linda Wiltse, Tax Manager of his firm, for calculating the results for each scenario.

The opinions expressed in this article are those of the author and do not necessarily reflect the views of the society.