The Alternative Minimum Tax, familiarly known as the AMT, is an alternate method of calculating tax liability.
In theory, the AMT is designed to prevent wealthier taxpayers from slashing their tax debts to a bare minimum by using all the deductions that are available under the regular tax rules.
It effectively takes away some of those deductions so these individuals pay taxes on more income. The rule is that an individual is responsible for paying either his regular tax or a minimum tax, but “minimum” is something of a misnomer. The taxpayer actually pays whichever of the two tax calculations comes out to be more, and that’s usually the AMT.
How the AMT Got Such a Bad Name
Initially, the income threshold at which the AMT started to kick in was not indexed for inflation, meaning that it remained the same year after year. Taxpayers who might have been considered wealthy decades ago weren’t so lush in the millennium. In fact, that threshold became more indicative of the middle class than the upper class as time went by. The AMT began hitting middle-income taxpayers unfairly hard, something it was never intended to do.
That changed with the American Taxpayer Relief Act that went into effect in January 2013.
Now the AMT threshold inches up incrementally year by year to keep pace with inflation. If you were never subject to the AMT, it’s now unlikely that your annual pay raises will push you over the limit. If you become a rock star overnight and your income suddenly doubles, however, you may very well find yourself dealing with this tax.
The same applies if your income is such that you’ve been teetering on a tightrope year to year between having to pay the AMT or dodging it. You might find yourself liable for the AMT in any given tax year if your income increases by more than the annual inflation adjustment.
How the AMT Works
The most important reason the AMT kicks in is income – or to be more precise, adjusted gross income.
Both your regular tax and AMT calculations start at the same place, on page one of your Form 1040. This is where your total income is entered. You can then subtract various adjustments to income, deductions that you do not have to itemize to claim. Some common adjustments to income include alimony you may have paid, a portion of self-employment tax and certain retirement plan contributions.
The result of all this subtracting is your adjusted gross income or AGI. From this point, the AMT and regular tax calculations part ways.
For regular income tax, you would next subtract either the standard deduction or the total of your itemized deductions from your AGI, as well as any personal exemptions you can claim. The result is your taxable income. This taxable income figure is the amount you’d use to look up the tax liability figures – your tax bracket – in the tax tables to find out how much you owe the IRS.
Taxable income for AMT purposes does not allow the standard deduction, personal exemptions or certain types of itemized deductions – and all these things can add up to a lot of money. Your income may jump significantly if you can’t subtract them, and the resulting number is what determines whether you have to pay the AMT because your income is over the inflation-adjusted threshold.
Itemized Deductions That Are Affected
The following expenses are not deductible when you’re calculating your AMT income, even though you can deduct them when calculating the regular tax.
- State and local income taxes
- Medical expenses
- Miscellaneous deductions such as employee business expenses and investment expenses
- Mortgage interest on home equity debt
- Accelerated depreciation
This list is not comprehensive. It reflects the typical adjustments most taxpayers are subject to.
Here’s the bottom line: If you have any deductions in these categories and they’re significant enough, this can trigger an AMT liability.
Other AMT Adjustments
Additionally, some types of income that are normally not taxable become taxable for purposes of calculating your income for the AMT. Yes, this is added back to your income, too. You must include the difference between the fair market value of incentive stock options and their strike price if the options are exercised and remain unsold at the end of the year. You must also include otherwise tax-exempt interest from private activity bonds.
The foreign tax credit, passive income and losses, and the net operating loss deduction are also recalculated for AMT purposes.
The AMT Exemption
The exemption is the threshold amount that is now adjusted for inflation.
|AMT Exemption Amounts and Phase-Outs for 2016|
|Filing status||Exemption Amount||The exemption amount is phased out starting at alternative minimum tax income of:||The exemption amount is fully phased out by AMTI of:|
|Head of Household||53,900||119,700||335,300|
|Married Filing Separately||41,900||79,850||247,450|
|Married Filing Jointly||83,800||159,700||494,900|
|AMT Exemption Amounts and Phase-Outs for 2017|
|Filing status||Exemption Amount||The exemption amount is phased out starting at AMTI of:||The exemption amount is fully phased out by AMTI of:|
|Head of Household||54,300||120,700||337,900|
|Married Filing Separately||42,250||80,450||249,450|
|Married Filing Jointly||84,500||160,900||498,900|
Phase-Out of the AMT Exemption Amount
The exemption amount functions something like a standard deduction for the AMT. In other words, in lieu of all the disallowed deductions and other adjustments, taxpayers can reduce their alternative minimum taxable income by the exemption amount. The alternative minimum tax is calculated on the remainder left over after the exemption amount has been subtracted from AMT income.
The exemption amount is variable – it gradually shrinks as income increases. The exemption amount is reduced or phased out by one-fourth of the difference between a person’s alternative minimum taxable income and the phase-out threshold amount. The phase-out is completed – meaning the exemption amount is reduced to zero – when AMT income reaches four times the exemption amount plus the phase-out threshold.
AMT Tax Rates
What’s left over after constructing the tax base of alternative minimum taxable income and calculating and subtracting the exemption amount is called a remainder amount. This remainder is multiplied against the AMT tax rates. There are just two tax rates: 26 percent and 28 percent.
For 2016, the threshold where the 26 percent AMT tax bracket ends and the 28 percent AMT tax bracket begins is:
- $93,150 for married filing separately
- $186,300 for all other filing statuses
For 2017, the threshold where the 26% AMT tax bracket ends and the 28% AMT tax bracket begins is:
- $93,900 for married filing separately
- $187,800 for all other filing statuses
Check to See if You’re Subject to the AMT
The Internal Revenue Service has an online calculator to help you figure out if you’re subject to the alternative minimum tax. It’s called the AMT Assistant for Individuals. There’s also a fairly quick worksheet in the Instructions for Form 1040. You can use this worksheet to determine if you’ll need to fill out the longer Form 6251 to compute your alternative minimum tax.
Most tax software programs will compute the alternative minimum tax automatically, but you might want to review the actual tax form anyway to understand which income or deductions are causing the AMT liability. For many taxpayers, deductions for state income tax, property tax and home equity interest and income from incentive stock options are the main causes.
AMT Tax Planning
Devising tax strategies around the alternative minimum tax can be tricky because the AMT adjusts for various deductions and credits. In general, however, tax professionals recommend the following planning tips:
- Seek reimbursements from your employer for business expenses incurred as an employee. These expenses are part of the miscellaneous itemized deductions, which are added back to your income for AMT purposes. By contrast, having your employer reimburse you for those expenses is a tax-free event to you and prevents a higher AMT adjustment.
- Review your state tax withholding so you pay in enough that you don’t owe but not enough that you substantially overpay. This will keep your state tax deduction as low as possible, thereby keeping your AMT adjustments as small as possible.
- Pay your property taxes when they’re due instead of prepaying your next installment by the end of the year. Again, this will keep your deduction for state and local taxes as low as possible.
- Sell exercised incentive stock options in the same year you exercise them. When you exercise and sell incentive stock options in the same year, you’ll be subject to the regular tax on the income but not the AMT. But if you exercise and don’t sell, the value of the exercised options because income for AMT purposes.
More Information on the IRS.gov Website