With the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), the income tax burden of affluent taxpayers has been reduced for the next few years, providing them with new options and opportunities to meet their long-term financial goals. This is a great opportunity for planners to help clients reach those goals.

While most of the JGTRRA tax relief is expected to benefit the affluent, some will find their tax relief is blocked by the alternative minimum tax (AMT). Most of the relief will not apply to AMT taxpayers and may actually make more taxpayers subject to AMT.

JGTRRA made two primary changes that benefit AMT taxpayers:

1. The Act increases the AMT exemption amount from $45,000 to $58,000 for married filing jointly, $33,750 to $40,250 for singles. These increases apply for years 2003 and 2004 only.

2. The Act reduces the tax rate to 15% on capital gains and dividend income and applies it to the AMT calculation.

The other highlights of the JGTRRA tax cuts will have little effect on AMT taxpayers.

The AMT has its own tax rate schedule that was not changed by the accelerated rate cuts under JGTRRA.

According to the Treasury Department, the AMT exemption amounts were increased so that the benefits from the accelerated reduction in individuals regular income tax rates were not diminished by the AMT.

Marriage penalty relief was provided by an expanded 15% bracket and increased standard deduction. The AMT generally does not affect taxpayers using the standard deduction.

Child tax credits are available to taxpayers subject to AMT. However, child tax credits phase out beginning at modified adjusted gross income over $110,000 married filing jointly and $75,000 unmarried. Therefore, credits may be totally phased out for most AMT taxpayers.

The increase in the AMT exemption will keep almost all taxpayers with less than $100,000 annual income from being subject to the AMT. The increased amounts are substantially higher than before but are less than those originally passed in both the House bill and the Senate amendment.

The increased exemption amount was fully intended to reduce taxes for AMT taxpayers. Because the AMT has only two rates, 26% and 28%, the exemption increase may provide AMT tax cuts of $3,380 or $3,640 to joint taxpayers and half that, $1,690 or $1,820, to single taxpayers.

Additionally, the capital gains and dividend rate cuts may provide healthy benefits to AMT taxpayers. For example, an AMT taxpayer receiving $10,000 of annual dividends (from a nonqualified portfolio worth approximately $300,000) will realize tax savings of $1,100 or $1,300. On $10,000 of capital gain, the tax cut provides an additional $500 over last year.

So who are the AMT taxpayers?

The AMT tax is triggered by two factors: income and the use of “tax preference items.”

With the new exemption amounts, taxpayers generally may be subject to the AMT if they have incomes between $100,000 and $500,000.

AMT taxpayers will also report a certain amount of “tax preference items.” These are generally investments or deductions that are provided special tax treatment. Common items include:

State and local taxes, with the property tax on “starter castles” often making a difference;

Vacation homes, in addition to two residences, that generate mortgage interest expenses along with property taxes;

Tax-exempt private activity bonds;

Passive activity investments;

Depreciable property; and/or,

Business interests that create net operating loss deductions.

(In other words, if they play the tax game too well, the AMT attacks!)

Life insurance and annuities are not tax-preference items for AMT purposes. And, because the AMT is also driven by income, using life insurance and annuities can help manage the AMT tax.

During accumulation, life insurance and annuities generally will not produce taxable income that may trigger or increase the tax. During distribution, the life insurance can provide withdrawals and loans with no effect on regular income tax or AMT; annuity income can be managed by withdrawals or annuitization options.

AMT taxpayers have an extra burden to bear while trying to accumulate assets for retirement. Before choosing investments or assets that are expected to produce income tax benefits, taxpayers who may be subject to the AMT should run sample tax returns to estimate the tax consequences.

JGTRRA will benefit AMT taxpayers; they would be wise to accumulate these tax savings in a manner that will not produce income subject to AMT tax.

However, the JGTRRA AMT change is scheduled to expire in 2005.

Someone who pays the AMT, or who barely escapes the AMT with the higher limits for 2003 and 2004, could face a more punishing AMT in 2005.

Paul J. Farrell, J.D., CLU, is assistant vice president, advanced case design for Jefferson Pilot Financial, Greensboro, N.C. He can be reached at Paul.Farrell@JPFinancial.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, October 24, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.