AMT Capital Gains Glitch
If you were caught by this odd glitch in the tax law, you may be
able to file for a refund.
Imagine that you prepared your tax return and were ready to
file when you realized you forgot to claim a deduction for one
of your state or local tax payments. So you change the numbers
on your tax return to include the additional deduction, and find
that your tax is now higher than it was without that
deduction. You must have made a mistake, right?
No, Congress made a mistake. There was a
glitch in the way capital gains are treated under the AMT, and
they fixed it in the Working Families Tax Relief Act of 2004.
The fix is retroactive, and this means you can apply for a
refund if you paid additional tax because of this problem during
any year that's recent enough for an amended return. Generally
that means returns filed in the last three years, so as of this
time (October 2004) most people who are affected can get refunds
for 2001, 2002 and 2003. If you filed your 2000 return on
October 15, 2001, you can still get a refund for that year also,
but you'll have to hurry.
Only a small number of taxpayers are affected, but some of
them are entitled to refunds of thousands of dollars. To be a
candidate for this refund, you had to have long-term capital
gain, and in the same year, either
- pay alternative minimum tax (AMT), or
- claim AMT credit, without being able to claim all your
available AMT credit.
Even then you aren't necessarily affected. If your
regular taxable income, including deductions, was large enough
to put you in a tax bracket higher than the 15% bracket, this
error in the tax law didn't increase your tax. The level of
taxable income where you'll be affected depends on your filing
status and which tax year we're talking about. For 2003, the
problem potentially affects singles with taxable income below
$28,400 and couples with taxable income below $56,800. Remember,
though, these numbers refer to taxable income, after
you've claimed your exemptions and all other deductions. You can
be affected even if you have a great deal of income, provided
that you also have sizeable deductions.
What's the problem?
The problem has to do with determining the amount of
long-term capital gain that qualifies for the 5% rate (rather
than the 15% rate) under the AMT. Congress intended to allow the
5% rate under the AMT to the same extent you would get it under
the regular income tax. In a drafting error, the law says you
get the 5% rate only to the extent you actually get that
rate under the regular income tax. That can make a big
Example: You and your spouse file jointly and have
no dependents. For 2003 your joint return shows $32,100 of
salary, $82,000 of long-term capital gain and $73,000 of
itemized deductions that aren't allowed under the AMT. Under
the regular income tax, your taxable income is $35,000
(salary and capital gain reduced by the itemized deductions
and $6,100 for personal exemptions). The deductions count
first against your salary income, so all your income is
taxed as capital gain. You're allowed to use the 5% rate for
long-term capital gain that falls below the taxable income
level of $56,800, so the entire $35,000 is taxed at 5%, for
a regular income tax of $1,750.
Under the AMT, you aren't allowed to claim these deductions.
After claiming the AMT exemption amount, you have $56,100 of
income. Once again it is all capital gain, and it should
all be taxed at the 5% rate because it's below the $56,800
threshold established by the end of the 15% tax bracket. But
only $35,000 of your capital gain was actually taxed
at the 5% rate under the regular income tax, so the poorly
written law required you to pay the 15% rate, instead of the
5% rate, on all your capital gain above $35,000. You end up
paying an extra 10% on over $20,000 of capital gain, so this
mistake in the law costs you over $2,000.
The new (October 2004) law fixes the problem. If your
situation happens to match the one in this example, you can
apply for a refund of more than $2,000.
The problem isn't a common one because relatively few
taxpayers with taxable income below the top of the 15% tax
bracket encounter alternative minimum tax. Yet if you have
unusually high deductions for items like state and local taxes
(including property tax) and/or a large number of personal
exemptions, you could have been hit with added tax on your
long-term capital gains because of this rule.
What to Do
Unfortunately, we don't have tax forms that tell us how to
calculate the correct amount of tax. Form 6251, used for
alternative minimum tax, requires you to use the calculation set
forth in the old law. The IRS will fix this for the 2004 tax
forms, of course, but it remains to be seen whether they will
create new versions of this form for earlier years, to make it
easier for the affected taxpayers to apply for refunds.
As a result, it probably makes sense to wait until we have
further guidance from the IRS before trying to obtain this
refund. Make sure you check your eligibility for the 2001 tax
year by April 15, 2005, though. After that, it may be too late
to claim your refund.
The only exception would be people who are about to lose the
ability to claim a refund for the year 2000, because they filed
on October 15, 2001. Those people should see a tax pro right
away if it appears this law may entitle them to a refund. You
can put in a refund claim now and worry later about fixing up
the paperwork if the IRS wants you to use a particular form for