The IRS's catch 22.

• Author: Stokes, Jeanie

JUST WHEN YOU THOUGHT YOU WERE GETTING A BREAK FROM LOWER INDIVIDUAL INCOME TAX RATES TAKING EFFECT FOR 2002, you could find yourself facing the federal governments version of Catch 22 -- the alternative minimum tax.

Sell a business or real estate for a capital gain, have a really good income year, take a lot of miscellaneous deductions or deduct a big state income tax from the previous year and you will likely be snared by the alternative minimum tax (AMT).

The result can be "an unexpected, significant additional tax" for middle income Americans, says accountant Greg Truitt, who chairs the Tax Study Group for the Colorado Society of CPAs.

Take Nick and Nora (not their real names), who normally had about $100,000 in annual income. The year they sold their long-time small business and reported a capital gain of about $1 million, their tax bill was $30,000 to $40,000 extra in AMT over what they would have paid in capital gains tax.

Why is that? The nation's first minimum tax was enacted in 1969 by a Congress reacting to reports that 155 individuals with adjusted gross incomes of more than $200,000 paid no federal income taxes in 1966. The AMT has evolved into a second formula for figuring taxes that excludes many traditional deductions allowed under the regular tax code.

And unlike regular income tax rates that take inflation into account, the AMT isn't indexed to anything. As salaries rise with inflation, more and more people fall subject to it -- an unintended consequence that hurts most when it catches the newly prosperous by surprise.

HITS MILLIONS

The General Accounting Office says the AMT affected about 1.3 million taxpayers in 2000 and generated about $5.8 billion in additional tax revenue for the government.

By the year 2010, about 17 million taxpayers, or one person in six, will be paying higher than normal income taxes because of the AMT. Over 10 years, the AMT is expected to contribute about $189 billion in additional tax revenue.

There's no set income level at which the AMT kicks in, although it exempts the first $35,700 of adjusted gross income for single taxpayers, $49,000 for married individuals filing jointly and $24,500 for married people filing single returns. Taxpayers who make more than that need to compute the taxes they owe by both the regular and AMT methods. Whichever generates the highest amount of tax owed, that's the one they pay. Congress last year raised the exemption thresholds slightly for the first time since...