Question: My wife and I were divorced early this year and, for the first time, I will not be filing a joint tax return. I began my tax preparation early because I knew I’d be receiving large refunds because I am paying taxable alimony and was able to deduct property taxes, some medical expenses, sales tax, and some of my attorney’s fees. In addition, I was able to maintain two rental properties that I am depreciating, and will have the exemptions for two of our three children. I also purchased a new car and used a home equity line so I could deduct the interest.

Needless to say, I was shocked when my CPA told me that I owed some taxes based on what he called the “AMT”. At first, I thought he was kidding and meant that I had taken too much money out of an “ATM”, but he is dead serious. How can it be that I have all of these deductions and don’t save any taxes?

Answer: The Alternative Minimum Tax (AMT) is part of a federal tax law that went into effect in 1996, and has been wreaking havoc with more and more unsuspecting taxpayers every year. The AMT was passed into law by Congress to stop wealthy taxpayers from significantly reducing their taxes by taking large deductions. At the risk of oversimplifying this complex issue, if your deductions lower your regular tax by too much, the AMT calculation steps in to make you pay more taxes.

The AMT has been applying to more taxpayers every year because the calculation of this tax is not indexed for inflation each year. In fact, studies reflect that the number of taxpayers saddled with paying the AMT will increase from 700,000 in 1997 to more than 9 million by 2007. And the AMT doesn’t apply to only the wealthy: In 1997, 26% of those who paid AMT had adjusted gross incomes of between $50,000 and $100,000, and by 2007, that percentage is anticipated to increase to 40%.

Here’s how the AMT works: After your regular tax is calculated, you are required to calculate your alternative minimum tax that, although based on a lower tax rate, doesn’t recognize a number of deductions and adds them back into your income. Then you pay whichever tax is larger. Let’s look at some of the deductible items and exemptions that you thought would reduce your taxes, but which are added back into your income and contribute to your AMT liability:

1) Exemptions for yourself and your children (and your spouse, if you have one) are disallowed for the alternative minimum tax calculation. The child tax credit that is allowed for your regular tax calculation is not allowed when figuring the AMT.

2) For tax years 2004 and 2005, you are able to claim your deduction for sales tax only if you don't claim a deduction for state or local income tax. You can’t claim both for AMT purposes.

3) While the AMT calculation allows your deduction for interest on your mortgage that was used to purchase, build or improve your home, it does not allow the interest deduction for the purchase of your automobile using the home equity line – even though banks tout the fact that we should use home equity loans to purchase automobiles.

4) The AMT computation will limit -- and may eliminate -- the medical expense deduction you take when you figure your regular income tax.

5) Some miscellaneous itemized deductions that are available to the extent that they exceed 2% of your adjusted gross income are not considered deductible when the AMT is calculated. So there goes your deduction for attorneys’ fees. This also includes tax preparation fees and a number of investment expenses.

6) Some depreciation deductions will be added back to generate your income for AMT purposes.

What to do? The alternative minimum tax is affecting more and more taxpayers, and it’s so complex that it is difficult to predict when or if it will apply. While Congress is allegedly studying ways to fix this sinister problem, it hasn’t happened yet, and all of us are potential targets. We suggest that you contact your Congressperson or Senator and complain about this regressive tax that, in effect, wipes out the income tax rate reductions they were crowing about earlier in this election year.