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Alternative Minimum Tax

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The alternative minimum tax was designed to capture tax revenue from high-income earners who were able to use loopholes to reduce their taxes. Since 1969, the alternative minimum tax spread beyond its targeted income group and affected many middle-class households.

What is the Alternative Minimum Tax (AMT)?

The alternative minimum tax (AMT) isn’t an additional tax but it can result in an additional amount due when you file. The alternative minimum tax is another method of calculating your tax liability. Tax filers are responsible for paying the higher of the two tax calculations: regular tax or the alternative minimum tax.

If you’re subject to the alternative minimum tax, this means two sets of calculations need to be performed when filing your taxes. The difference between your standard tax rate and your tax liability as calculated using the alternative minimum tax rate gets added to your overall tax liability.

To use a simple example, if your tax liability using the standard calculation was $10,000 and your tax liability using the alternative minimum tax was $11,000, you would have to add $1,000 to the tax amount due on your 1040 form (schedule 2).

Form 1040 schedule 2 for the Alternative Minimum Tax
Source:https://www.irs.gov/pub/irs-pdf/f1040s2.pdf

Up until 2018, many U.S. households could benefit from itemizing deductions, thereby reducing their tax liability. The alternative minimum tax negated or reduced many of these deductions. This meant the deducted amount would have to be added back to taxable income to calculate the alternative minimum tax amount.

With recent tax changes that increased the standard deduction but reduced or eliminated many other common deductions, the difference between the regular tax rate and the alternative minimum tax rate for many households may be $0, or much less than the difference would have been in the past. This means fewer households are subject to the alternative minimum tax.

Who Has to Pay the Alternative Minimum Tax?

In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA). This spared many households from the alternative minimum tax because it changed the deductions that had to be added back when calculating the AMT. Prior to TCJA, the alternative minimum tax was more likely to affect households with large families, married households and households located in high-tax states.

Changes implemented with the TCJA change how the AMT is applied from 2018 through 2025. Without additional legislation, the changes that save many households from the AMT will sunset in 2025, returning to its original structure in 2026.

While many middle-income and upper-income taxpayers are now shielded from the AMT, it’s important to understand how the AMT works and if it applies to your taxes.

Like many tax rules, the AMT is based on your adjusted gross income (AGI), with a fixed amount of income exempt from the tax. This exemption protects lower-income households from the AMT. The provisions of the TCJA return many of the deductions that taxpayers lost in AMT calculations up until 2017, which help the vast majority of households to avoid the AMT.

For 2018 through 2025, the AMT provides new AGI income exemptions and phase-outs. Income below the exemption amount isn’t subject to the alternative minimum tax.

Tax filing status2017 AMT exemption2018-2025 AMT exemption
Single or head of household$54,300$70,300
Married filing jointly$84,500$109,400
Married filing separately$42,250$54,700

Phaseouts have increased dramatically as well and protect more income from reductions to the exemption amount and shield all but a small percentage of households from the AMT by keeping the exemption amounts intact.

Tax filing status2017 phaseout2018-2025 phaseout
Single or head of household$120,700$500,000
Married filing jointly$160,900$1,000,000
Married filing separately$80,450$500,000

The AMT phaseout works like a clawback and reduces the benefit of the exemption amount. For every dollar of income above the phaseout threshold, the exemption amount is reduced by $0.25. Through 2025, the phaseout should be a smaller concern for most households and works to the taxpayer’s benefit in most cases due to higher phaseout limits.

Can You Avoid or be Exempt from the AMT?

The AMT can be difficult to avoid, but the Tax Cuts and Jobs Act has removed most households from its reach for the time being. With this legislation in place, those with incomes above $1,000,000 are most likely to be affected by the alternative minimum tax, where an estimated 11.5 percent of taxpayers are affected.

A much smaller percentage of those with an adjusted gross income between $200,000 and $500,000 and those between $500,000 and $1,000,000 will pay the tax.

Depending on your income and how close you are to the threshold, there may be some ways to avoid the AMT or reduce the amount of income subject to AMT. Many of these options are the same choice you might consider using to help reduce your regular tax liability.

  • Look at options that can reduce your adjusted gross income, including retirement plan contributions.
  • Prepaying property taxes can work against you because you aren’t able to use the deduction for property taxes to reduce the AMT. State and local income taxes fall into the same category and aren’t deductible when calculating the AMT.
  • Medical expenses are only allowed as deductions under the AMT if they exceed 10% of your adjusted gross income, which limits their impact on the AMT. Participating in an employer-sponsored healthcare plan can reduce your adjusted gross income.
  • Stock options offered through an employer can also be a factor in calculating the AMT. Consider the timing of your sales to reduce your AMT exposure if you have a sizeable gain in incentive stock options (ISO) compared to the current market value.
  • An AMT credit may also be available if you paid AMT in the prior year or may be available to you next year if you paid AMT this year.

How to Calculate the AMT

Form 6251 will walk you through the calculation for the AMT, although tax software will make the job much easier. Form 6251 is comprised of two parts, each with several calculations that increase the likelihood of computational errors. The best tax software translates often complicated IRS instructions into plain English and pulls in data from other tax forms automatically and do the AMT calculations for you.

Form 6251 for Alternative Minimum Tax
Source:https://www.irs.gov/pub/irs-pdf/f6251.pdf

If you’re subject to the AMT, there are two primary tax rates that can apply to the AMT income on Form 6251. For most people who are filing taxes, the rates will be either 26 percent or 28 percent. However, AMT calculations also consider foreign earned income as well as some capital gains distributions and qualified distributions.

Because the TCJA lets tax filers keep most deductions, only a handful of deductions allowed under regular taxes are disallowed under AMT. For example, state taxes, local taxes and property taxes for your home aren’t allowable deductions under the AMT.

To use a simple example, let’s consider a taxpayer with an adjusted gross income of $150,000 who also had $8,000 in property taxes and $10,000 in state and local taxes. Form 6251 provides the following guidance:

All others: If line 6 is $191,100 or less ($95,550 or less if married filing separately), multiply line 6 by 26 percent (0.26). Otherwise, multiply line 6 by 28 percent (0.28) and subtract $3,822 ($1,911 if married filing separately) from the result.

The local taxes and property taxes aren’t allowable deductions under the AMT and have to be added back to the adjusted gross income, which gives an alternative minimum taxable income (AMTI) of $168,000.

The AMTI of $168,000 falls into the first tax bracket because it’s under $191,100 and makes it taxable at 26 percent. This gives an AMT of $43,680. However, the new exemption limit reduces both the AMTI and the AMT amount itself. Because the AMT is less than $50,000, this taxpayer gets the full exemption amount of $70,300.

After the exemption of $70,300, the new amount subject to the AMT is $97,000, which creates an AMT of $25,402.

If the AMT is less than the regular tax, no AMT tax is due. If the AMT tax amount is higher, the AMT tax must be paid. Form 1040 provides a section to include the additional amount due for AMT.

For incomes above the phaseout amounts, the AMT exemptions are reduced by $0.25 for every dollar in income above the phaseout threshold. For example, a single filer with an AMTI of $600,000 is $100,000 above the threshold and the exemption amount would be reduced by $25,000 from $70,300 to $45,300, making more income subject to AMT.

Phaseouts reduce the AMT exemptions to zero at $1,437,600 for couples filing jointly and $781,200 for heads of household or single filers. Married filers filing separately lose 100 percent of their AMT exemption at an AMTI of $718,800 or higher.

Getting the AMT Right

If you aren’t liable for the AMT or similar taxes like foreign earned income, you may be able to file taxes with free tax software. If your taxes include investment income, AMT, foreign-earned income or access to additional tax forms, paid tax software options include more options and access to more IRS forms.

While the AMT affects fewer taxpayers now, it hasn’t gone away completely and you’ll want to be sure to calculate your tax liability correctly.