Avoiding the tax trap of too many shelters
If someone beats you at your own game, change the rules. That seems to be what Congress and the Internal Revenue Service have done to some wealthy taxpayers. Many of these taxpayers had piled up so many deductions through tax shelters and long-term capital gains that they almost avoided paying any federal tax at all. True, these shelters were usually fully legitimate. And they are still legitimate, even under the tightened rules of last years's Tax Equity and Fiscal Responsibility Act.
But according to that same tax law, it is possible to have too many shelters, even legal ones. If you do, there may be an unpleasant surprise coming next spring when it comes time to pay the tax bill. You may have fallen into what tax experts call the ''alternative minimum tax trap.''
People who have invested in several tax shelters should get together with their tax adviser now - before the end of the year. Your share of some of those oil and gas deals, research-and-development partnerships, or real estate projects may have to be sold.
Essentially, what the IRS wants to do is make sure high-bracket taxpayers do not pay less than a 20 percent rate. (''High bracket'' means people who are at or very near the 50 percent level. For a married couple filing jointly, this is an annual income of $109,400.) So investors who expect to claim a large amount of long-term capital gains or several ''tax preference items'' will find they are still paying a minimum 20 percent tax on all their income. The IRS will continue to let you take tax shelter deductions, but if they reduce the tax obligation to less than 20 percent, the alternative minimum tax (AMT) is triggered.
''After a certain point, there's no further benefit in having certain kinds of shelters,'' says Marilyn Pitchford, a tax partner in the Boston office of Arthur Young & Co. ''If you're counting on the losses and the tax benefit of the losses to provide the economics for the investment, you have to make sure your own situation is compatible with the economics of the shelter.'' In other words, you may come out ahead by not investing in the shelter at all.
While investors in tax shelters should consult with a professional before making any moves, there is a way to find out if a problem might exist.
First figure out your adjusted gross income. This is your gross income minus any tax-shelter losses, business expense, and your capital gain exclusion - to 60 percent of long-term gain that is not taxed.
Once this adjusted gross income is figured, add back any tax preference items and the capital gain exclusion, plus proceeds from any incentive stock options. This is your ''gross alternative minimum taxable income.''
Now, subtract certain itemized deductions. This includes mortgage interest on your residence, charitable contributions, and limited amounts of medical and casualty deductions. Then give yourself the AMT personal exemption, which is $30 ,000 on an individual and $40,000 on a joint return.
Subtracting all these from the gross alternative minimum tax gives your ''net AMT income.'' Take 20 percent of this figure to find how big your tax obligation is. If this 20 percent is smaller than your normal federal tax obligation, there is no problem. If it is larger, however, you have probably oversheltered.
If you are in this situation, Ms. Pitchford says, ''you may be better off to sell some securities you've been holding on margin (by borrowing from your broker), or pay off some loans. Or you may want to find ways to simply generate some ordinary income.''
In future years, she adds, the AMT trap may catch fewer people because of greater awareness. But people thinking of investing in tax shelters early next year - and the better shelters are usually offered early in the year - should keep track of them throughout the year to prevent falling into the trap later.
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