The tax laws give special treatment to certain types of income, deductions, and credits. The AMT is designed to make sure that the taxpayers who benefit from these laws share some part of the federal tax burden. The AMT is payable to the extent it exceeds your regular tax liability.

The AMT rate is 26% or 28%, depending on the amount that is subject to tax. In addition, there are special rates applicable to net capital gains. The taxable amount is the amount by which your "alternative minimum taxable income" exceeds your exemption amount. The exemption amounts for 2006 are $62,550 for joint returns; $42,500 for single returns; and $31,275 for married filing separately. Note, however, that the exemption amount is phased out at the rate of 25 cents for every dollar of taxable income in excess of $112,500 for single individuals, $150,000 for married couples, and $75,000 for married taxpayers filing separately.

The first step in determining your AMT liability is to compute your "alternative minimum taxable income" (AMTI). To do this, start with "taxable income" from Form 1040, then make certain changes to eliminate the tax advantages resulting from the items that received special treatment. Here is a summary of the major changes:

1. Personal Exemption; Standard Deduction; Itemized Deductions: Personal exemptions and standard deductions claimed in computing your regular tax must be added to taxable income. For itemized deductions, you must add back to taxable income all deductions that were subject to the 2% floor. In addition, the overall limitation on itemized deductions does not apply in determining AMTI. You also must make the following modifications:

2. Medical Expenses: You can deduct medical expenses that exceed 10% of your adjusted gross income (AGI). Since for regular tax purposes, you can deduct such expenses that exceed 7.5% of AGI, add back the lesser of 2.5% of AGI or the amount you deducted for regular tax purposes.

3. Taxes: Add back amounts deducted for state, local or foreign income taxes; real property taxes; and state and local personal property taxes.

4. Home Mortgage Interest: Home mortgage interest is generally deductible for AMT purposes. Interest on mortgages can be deducted only if the debt is for acquiring, constructing, or substantially improving a residence. Interest on refinances taken out after June 30, 1982, is not deductible to the extent it is attributable to debt that exceeds the amount of the original mortgage.

5. Investment Interest: Investment interest expenses are deductible only to the extent of investment interest income (including tax-exempt interest on private activity bonds).

6. Accelerated Depreciation: For most types of property placed in service after December 31, 1998, there is no longer an AMT depreciation adjustment. However, for certain property placed in service after 1998 and for most types of property placed in service before 1998, there may be an applicable AMT adjustment. Note that, since the AMT depreciation deduction differs from the amount allowable for regular tax purposes, taxpayers who have AMT liability will have a different basis in the property for AMT purposes than for regular tax purposes. This means that the amount of gain or loss on sale or other disposition will be different for AMT purposes. Also, note that deductions for amortization of pollution control facilities are determined under the alternate MACRS rules.
7. Circulation Costs: These costs must be amortized over a three-year period.
8. Research & Experimental Expenditures; Mining Exploration & Development Costs: These costs generally must be amortized over ten years. Thus, the AMT adjustment is the difference between the amount deducted for regular tax purposes and the re-computed figure. If you materially participated in the activity, such expenses may be expensed and deducted currently.
9. Long-term Contracts: For long-term contracts entered into after February 28, 1986, income must be computed using the percentage of completion method, except in the case of certain "home construction" contracts.
10. Tax Shelter Farm Losses: Losses from tax shelter farm activities are not allowed in computing AMT liability. Such losses are allowed in later years to offset income from that activity or to offset gain on a disposition of your entire interest in the property.
11. Passive Losses: Passive losses must be recomputed using the AMT adjustments and preferences rather than those applicable for the regular income tax. The AMT adjustment is the difference between the figure reported on Form 1040 and the recomputed amount.
12. Incentive Stock Options: If the fair market value of stock (at the date of grant) was more than the price you paid, the difference is a tax preference and must be added to taxable income in computing AMTI.

After making the above adjustments to taxable income, add your tax preference items back to taxable income. These items include:

• Excess intangible drilling and development costs

• Bad debt reserves of financial institutions (before 1996)

• Tax-exempt interest on bonds issued after August 7, 1986

• Accelerated depreciation on pre-1981 real property

• Accelerated depreciation on pre-1981 leased personal property

• Accelerated depreciation on property placed in service during 1981 through 1986 (ACRS Property)

• Amortization of pollution control facilities placed in service before 1987

• A percentage of the amount excluded from gross income on the sale of "qualified small business stock."

Next, subtract your exemption amount to obtain the taxable amount. Assuming no net capital gain, multiplying up to $175,000 by 26% and any amount in excess of $175,000 by 28% yields your pre-credit tentative AMT liability. Next, any available alternative minimum tax foreign tax credit is subtracted. The resulting figure (tentative minimum tax) is compared with you regular tax liability. If your tentative minimum tax exceeds your regular tax, you have a net AMT liability and are liable for both your regular tax and the net AMT liability.

Note that there are other AMT rules that might apply in certain situations. For example, if you have a net operating loss, that loss must be computed differently for AMT purposes than for regular tax purposes.

If you have any questions, please feel free to contact me.