It’s never too early for AMT avoidance strategies

CHICAGO — Even though tax season just wrapped up, financial advisers and tax specialists say that it isn’t too early to help clients try to avoid the alternative minimum tax for 2007 returns. Many advisers are hoping that Congress fixes what they call the AMT problem, but they say they can’t count on it and instead are trying to plan as early as possible. “The standard wisdom is that it makes sense to be working on your planning all year long,” said Kaye Thomas, a tax lawyer and consultant based in Lisle, Ill. He is the proprietor of Fairmark Press Inc. and writes books on taxes and investing. “If the only time you think about taxes is just before the end of year, you miss opportunities,” Mr. Thomas said. The AMT was set up as a parallel tax system to prevent a small number of wealthy individuals from using tax breaks to diminish their tax burden, but over time, it has crossed over to middle-class individuals, as it has never been adjusted to inflation. The people who are most vulnerable to fall within the AMT are those with income of $150,000 to $400,000, Mr. Thomas said. The people affected by the AMT often are those who pay steep state and local taxes, and who have a large number of personal exemptions such as dependents. The problem with some strategies to avoid the AMT, advisers say, is that clients may be forced to make tough choices such as accepting lower yields simply to avoid the AMT. For participants in tax-exempt bonds, the best strategy is to re-evaluate those bonds now and make sure they aren’t subject to the AMT, Mr. Thomas said. He said that some companies offer so-called AMT-free funds. Each company has a clear prospectus that outlines whether the bonds are subject to the AMT or not. It is important to get clients to make a tough decision when they’re deciding if they want to avoid the AMT, Mr. Thomas said. Would clients rather have a higher yield on their bonds, knowing that they might be forced to pay the AMT, or accept a lower yield and potentially avoid the AMT? Bonds subject to the AMT traditionally have a slightly higher interest rate, because they’re less marketable, Mr. Thomas said. “If you’re just looking for the highest-yield fund, there are ways to get higher yield,” he said. That is a common dilemma, said Dave Young, president of Paragon Wealth Management in Provo, Utah. He has found that clients often get annoyed by low yields on bonds and aren’t worried about paying taxes — at least not until tax season rolls around. “They look at their statement, and all they look at is its yield, and they don’t care about the tax rate,” Mr. Young said. But he said talking about these situations early in the year is important. “For any tax planning, you need to do it right now,” Mr. Young said. “Everyone always thinks about it right before you’re filing your taxes.” Mr. Young disagrees with the way the AMT is set up and has had to pay it several times himself. Sometimes strategies to avoid the tax just don’t work. In the past, Mr. Young made small changes in his own personal finances, only to find that he still had to pay the AMT. “For normal tax planning, there are all kinds of things you can do to prepare for it,” he said, “but the AMT is just an insidious tax.” In recent years, Congress has enacted a one-year fix, commonly referred to as a “patch,” that essentially keeps the number of AMT taxpayers down. Another significant reason that taxpayers fall into the AMT is incentive tax options. A popular strategy for many workers to avoid being taxed at ordinary income rates — up to 35% — is to hold on to the stock for a year and be taxed at the long-term capital gains rate of 15%. If a person sells the stock, they don’t have to worry about the AMT, Mr. Thomas said. But they should consider that decision carefully, because then they have to pay the steeper tax rate. “Don’t say, ‘I’m scared of the AMT and want to sell all stock immediately,’” Mr. Thomas said. “If you completely ignore this tax benefit, you are giving up a rich benefit.”