Most of us have heard of the term Alternative Minimum Tax, Alt Min Tax, or AMT. But what is it? Alternative Minimum Tax is a tax system that parallels the standard tax systems and adds an additional level of taxation to baseline income tax for certain individuals, corporations, estates and trust. Traditional tax is adjusted for certain items and computed differently for AMT. Some of these items are depreciation, medical expenses, state taxes, certain mortgage interest, real estate and personal property taxes. AMT was first introduced in 1969 when Congressed determined that a portion of the population with high incomes, roughly one-hundred-fifty-five million taxpayers, were able to utilize tax deductions and other tax breaks to the point where they were paying almost nothing in taxes. The Reagan Administration created what we currently know as Alternative Minimum Tax that included more widespread exemptions and deductions while eliminating some of the investment deductions that only applied to the very wealthy.
For those that make more than the AMT exemption and utilize the deductions that are modified or disallowed, you must calculate your taxes twice. Then, in accordance with AMT regulations, you must pay the higher of the two tax calculations. One of the biggest issues with AMT is the fact that it was never indexed for inflation. Therefore, more and more taxpayers are becoming subject to it. Congress passed several patches throughout the years that raised the income thresholds. Without these fixes, families with incomes as low as $30,000 would have been subject to AMT. In 2013, the American Taxpayer Relief Act automatically adjusted the income thresholds. In the 2017 Tax Cuts and Jobs Act (TCJA), the exemption limit was raised, as well as the phaseout levels, through 2025. It also included an automatic cost of living adjustment. Congress went on to eliminate AMT for corporations.
Alternative Minim Tax differs from the traditional tax rate because it does not make use of the standard deduction or any personal exemptions. Nor does it allow for certain itemized deductions, as mentioned above. AMT includes additional income streams as well. These are the fair market value of incentive stock options that were exercised but not sold, tax-exempt interest from private activity bonds, foreign tax credits, passive income and losses, and net operating loss deductions. These changes often make AMT tax rates higher that traditional rates. The offset is that AMT tax rates are simpler. There are only two rates instead of the rates that apply with traditional taxes, the twenty-eight percent rate and the thirty-nine-point-six percent rate. The exemption is larger than that of the traditional tax rate, but also has a phaseout limitation. For 2018 through 2025 the exemption is $70,300 for Single and Head of Household, while it is $109,400 for Married Filing Jointly. The phase out for each begins at $500,000 and $1 Million respectively.
It is important to note that before TCJA, many high-income taxpayers weren’t affected by the Alternative Minimum Tax, even though this was the reason for AMT’s original creation and installation. This was due to the fact that, after multiple legislative changes, many of their tax breaks were already cut back or eliminated under the regular income tax rules. Therefore, there was no need to address the AMT issues. If the taxpayer’s income exceeded certain levels, phaseout rules chipped away and/or eliminate other tax breaks. As a result, higher-income taxpayers had little or nothing left to lose by the time they got to the AMT calculation, while many upper-middle-income folks still had plenty left to lose. Also, the highest earners were in the 39.6% regular federal income tax bracket under prior law, which made it less likely that the Alternative Minimum Tax, with a maximum twenty-eight percent tax rate, would affect them. In addition, the AMT exemption is phased out as income goes up. This amount is deducted in calculating AMT income. Under previous law, this exemption had little or no impact on individuals in the top bracket because the exemption was completely phased out. But the exemption phaseout rule made upper-middle-income taxpayers more likely to owe AMT under previous law. Suffice it to say that, under the TCJA, high-income earners are back in the AMT spotlight. So, proper planning is essential.
The first thing you must do is figure out if you are subject to AMT. Most tax software runs a side by side calculation for you, and there are many calculators online. Various factors make it difficult to pinpoint exactly who will be subject to AMT. Those with higher income, from any source, should be aware of AMT and the AMT phaseout. With the exemption and phase out adjustments from the TCJA, the higher income taxpayers will be faced with the phase out, while the upper-middle class will still see a benefit from the full exemption. So, although TCJA reduces the odds that you will owe AMT, be sure not to assume that you are AMT exempt. Once you have determined that you fall under AMT rate, there isn’t much you can do about it unfortunately. A few things you can do to plan ahead are: lowering your adjusted gross income by maxing contributions to a 401(k), IRA or health savings account; reducing itemized deductions; increase charitable contributions; and paying attention to long-term capital gains.
Once you qualify for AMT and have paid it in the past, you may qualify for the Alternative Minimum Tax Credit. This credit is calculated using the amount of deferred items, which generate credit in subsequent years, versus the excluded items, which are not deductible and are consequently lost. Other items create timing differences, such as depreciation, can also be used to create this credit and help you reduce your taxes in the future. Also, be sure to check your prior return for any business credit that may carry forward.
AMT can be a confusing topic. With the new changes to the standard deduction, exemptions and Alternative Minimum Tax requirements brought on by TCJA, it is more important now to seek the advice of a tax professional if you feel that AMT may apply to you.