Watch out for the government's AMT trump card!

by John Pearson

Personal Finance

July 2006

The top tax rate on long term capital gains and dividend income is 15%. Right?

That figure is in all the instruction booklets for your 1040. So it has to be true! Right?

Careful! The alternative minimum tax (AMT) can trump that rate with a higher one.

The Urban-Brookings Tax Policy Center estimates that nearly 64 percent of those earning $100,000 to $200,000 annually will face the AMT on 2006 income - a possible 20 million taxpayers. For many of them the AMT will raise the effective tax rate on capital gains and dividends to as high as 22 percent.

How does this apply to financial aid? Often a family saving for their kid's college sells off a stock that they have been holding for years to pay the tuition bill. The sudden rise in income from the capital gain catapults them over the $150,000 AMT threshold, and presto…15 percent turns into a higher tax rate by surprise. Meanwhile, less money than expected may be available for college expenses.

A solution? Gift the stock to the child. Let the child sell it and pay for college. Not only will the tax rate be lower -- it could be 5 percent, or better yet zero! It may also make the child eligible for the Hope or Lifetime learning tax credits, which the parents might not receive because their income is too high.

John Pearson is a CPA and certified college planning specialist. He can be reached at john@johnpearsoncpa.com.