The alternative minimum tax (AMT) is a poster child for what is wrong with our tax system. It was originally enacted in 1969 to prevent a few hundred high-income taxpayers from avoiding federal taxes by using tax shelters. Since then it has evolved into a complicated and poorly understood "stealth" tax that will impact over 21 million taxpayers in 2006.

The AMT is essentially a separate, parallel federal tax system with different rules for taxation, deductions and exemptions. Anyone subject to AMT must calculate their taxes twice - once using the regular tax system, and again under the AMT rules. If the tax due is greater under AMT, then the higher tax must be paid.

To help taxpayers better understand this part of the tax law, perhaps it should be renamed the "MMT" - the Mandatory Maximum Tax. The word "alternative" means you have a choice, but you don't. It also isn't a "minimum" tax, because you have to pay the maximum of the two taxes calculated.

The biggest differences are the deductions that you are able to take under the regular tax system, but are not able to deduct under the AMT. These include personal exemptions and standard deductions, so families with children, or those who live in high-tax states are more likely to get hit with the AMT penalty tax.

Other expenses not deductible under the AMT include medical expenses, state and local taxes, and real estate taxes. And one that will make many homeowners very unhappy is that home mortgage interest is not deductible under AMT unless the loan is used to purchase or improve a primary residence. This means that many homeowners who have refinanced their mortgage or taken out a home equity loan will not be able to deduct all of the interest on that loan under the AMT.

The biggest problem is that the AMT is not indexed for inflation, so it affects more Americans every year. It was originally designed to make sure that millionaires paid taxes, but in 2006 it will hit married couples with only $62,550 of gross income.

So why doesn't Congress change or eliminate the AMT? Because they are "addicted" to the tax income! According to the U.S. Treasury, by 2014, unless changes are made, the AMT tax will cost taxpayers an estimated $177 billion - more than it expects the regular tax system to generate that year. Something must be done. (Wall Street Journal 4/15/06 & 12/15/05, and Investment Advisor October 2005)

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