AMT (or alternative minimum tax) is a parallel tax system that was set up with the idea that all taxpayers should pay something in taxes each year. Originally designed for the wealthiest taxpayers, AMT has adapted over the years to catch more and more middle-income families. It's becoming more and more of a challenge to keep AMT at arm's length.

After last year's elections the new Democratic majority issued notices saying that at last the elephant in the room would be acknowledged and dealt with. Yet with 90-odd days until the end of the year, there's not much going on. Charles Rangel, (D-NY) is working on proposed legislation to repeal AMT but it's not going to be ready any time soon, nor does it have much support from either side in Washington.

The problem, in a nutshell, is money. AMT makes the government gobs of money. In fact, the cost of phasing out AMT is estimated to be as much as 10 trillion dollars. No matter what your party affiliation, looking at a revenue loss of that magnitude is going to be a bitter pill to swallow.

Besides, making AMT go away will probably come at the cost of other loopholes. Rangel acknowledged that his proposed legislation would be revenue-neutral, which could potentially mean closing loopholes and possible raising rates on top income earners to cover the cost of eliminating AMT.

So what can we expect before December? Well, last year just over 4 million taxpayers paid AMT. If Congress doesn't pass even an inflation adjustment patch about 23 million taxpayers can expect to be slammed with AMT next April. Even if Congress does pass an inflation adjustment patch, estimates are that about 5½ million taxpayers will still face AMT next year.

When you fall subject to AMT, you lose many of the deductions that were available before. AMT was designed to disallow passive losses from tax shelters, depreciation of property and tax-exempt interest, among other things. It’s especially bad if you life in a high-tax state like California, New Hampshire, New York, Vermont, or Washington, DC, because one of the deductions you lose is the ability to deduct state income, sales, and property taxes. In fact, some studies estimate that 90 percent of taxpayers paying AMT now are paying it because they live in a high-tax state.

So who's in line for the AMT hit? In a nutshell … you! Expect some AMT complications if you:

• Have a gross household income of $50,000+;

• Claim a large number of exemptions;

• Itemize deductions and claim large deductions for taxes and/or miscellaneous deductions subject to the 2 percent of AGI (adjusted gross income) limit;

• Live in a high tax state;

• Have a home mortgage or equity line of credit

• Exercise incentive stock options and don't sell the stock in the same year;

• Own real estate investments and use accelerated (not straight line) depreciation; or

• Have long-term capital gains (investment sold that was held for over one year).

If you find yourself falling into the AMT trap, then perhaps the single-biggest piece of advice I can give you is:

• Start a business; and

• Start a business pension plan.

Loopholes for businesses have kept coming over the years, to the point where most businesses are no longer subject to AMT. When you operate through a business and take all of the pre-tax deductions available to a true business, you recapture many deductions that may be disallowed on your personal return.

The second part of this equation is starting a business pension fund and putting as much money into it as you possibly can. That's because pension contributions are deductible under AMT and can work to reduce your income to a level where you can escape the AMT trap.

If you really want to maximize this side, I'd recommend going with either a Solo 401(k) or a Solo Roth 401(k) plan, if your business qualifies (to qualify you and your spouse must be the only owners, it must be the type of business that pays you earned income, and you cannot have any employees who work more than 1,000 hours per year). Assuming your business does qualify, you are able to put away salary and profit draw contributions of up to $49,000 per person this year - as long as you do it before December 31st.

Published: October 11, 2007

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Diane Kennedy, the nation's pre-eminent tax strategist, is owner of Diane Kennedy & Associates, a leading tax strategy and accounting firm and founder of TaxLoopholes. She is the author of The Wall Street Journal and Business Week bestsellers, Loopholes of the Rich and Real Estate Loopholes, and co-author of The Insider's Guide to Real Estate Investing Loopholes, The Insider's Guide to Making Money in Real Estate, and TaxLoopholes for eBay Sellers. Register for free Tax Strategy updates and e-Newsletters delivered via email from TaxLoopholes.com. You will be updated on current tax law changes as well as proactive tax strategies the wealthy use plus news regarding Diane Kennedy.