Did you know that you are supposed to calculate your taxes in two different ways?
First, you calculate your tax liability under the ordinary tax system, which takes into account the preferential treatment of certain income and allows tax credits for certain types of expenses. Then you calculate your taxes using the Alternative Minimum Tax (AMT) rules, which eliminates certain tax deductions and credits. If the AMT is higher, you will be subject to tax in addition to your regular income tax. Read on to learn more about reducing your AMT.
Key points to remember
- The Alternative Minimum Tax (AMT) ensures that some taxpayers pay their fair share of income tax.
- However, the structure was not indexed to inflation or tax cuts. This can lead to a shift in tax brackets, a condition in which upper-middle-income taxpayers are subject to this tax instead of just wealthy taxpayers for whom AMT was invented.
- For people subject to AMT, certain strategies can be used to reduce your exposure to this tax.
What is AMT?
The Alternative Minimum Tax, or AMT, was instituted in the late 1960s to ensure that high-income individuals pay at least a minimum amount of federal income tax. The AMT is like a fictitious tax because it has its own rules for deductions, its own exemptions, and its own tax rates of 26% and 28%. The AMT is only paid when it entails a higher tax than the income tax calculated on a regular basis (before any tax credit).
Should we be worried about AMT?
Your chances of paying this tax increase if you:
- Have a large family. Personal exemptions are not deductible for AMT purposes.
- Live in an area with high property taxes and / or state and local income taxes. Itemized personal taxes are not deductible in computing your income for AMT purposes.
- Claim various large itemized deductions, including employee capital expenses or unreimbursed business expenses. Various itemized deductions are not deductible for AMT purposes.
- Exercise and hold incentive stock options (ISO). While the exercise of ISOs has no ordinary tax impact, the difference between the purchase price and the grant price is included in income for AMT purposes.
- Hold private activity bonds. Although interest on these bonds (other than bonds issued in 2009 and 2010) is exempt from ordinary income tax, it is taken into account for AMT purposes.
Will you need AMT?
There is no way to know if you owe the AMT by guessing because there are so many factors that go into it. These include the types of income and expenses you have and your filing status. If your regular tax bill puts you in a higher tax bracket than 28% (the upper tax brackets are 33%, 35%, and 36.9%), you will not owe the AMT because you already pay more regular taxes. But don’t assume that because you fall into a tax bracket lower than the AMT tax rates of 26% and 28% (10%, 12% and 25%), you are exempt from the AMT.
Adjustments to your income for regular tax purposes may increase your exposure to AMT. Those in the 28% tax bracket for regular tax purposes should also see if their AMT calculations produce a higher overall tax bill than under regular tax rules.
AMT exemption amounts
For 2-2-, you can reduce your income for AMT purposes (technically called Alternative Taxable Minimum Income, or AMTI) by an exemption amount. This can reduce or eliminate your exposure to AMT. As with many tax rules, the amount of the exemption depends on your tax status. Here are the exemption amounts for 2020:
- Single: $ 72,900
- Married declaring jointly or widow eligible: $ 113,400
- Bride and groom deposit separately: $ 56,750
To note: A special exemption applies to a child subject to the âkiddie taxâ on capital income. For 2015, the exemption is the sum of the child’s earned income plus $ 7,900; this amount cannot exceed the exemption that would otherwise apply (eg $ 72,900 for a single person, including a child).
The amount of the exemption begins to disappear when the AMTI exceeds in 2020:
- Single: $ 518,400
- Married declaring jointly or widow eligible: $ 1,036,800
- Head of household: $ 518,400
- Bride and groom deposit separately: $ 518,400
Fill out form 6251
To determine if you are subject to the AMT, you will need to complete Form 6251.
How to reduce AMT
A good strategy to minimize your AMT liability is to keep your Adjusted Gross Income (AGI) as low as possible. Some options:
- Participate in a 401 (k), 403 (b), SARSEP, 457 (b) or SIMPLE IRA plan by making the maximum allowable wage deferral contributions. The self-employed can also make tax-deductible contributions to 401 (k) or other types of qualified pension plans to reduce their AGI.
- Make pre-tax contributions to flexible expense accounts. There are FSAs for health coverage and help for dependents.
- Use employer-sponsored cafeteria plans to pay for other expenses, such as life insurance, on a pre-tax basis and reduce your taxable compensation accordingly.
- Reposition the investment holdings in your taxable investment portfolio. For example, consider switching to tax-efficient mutual funds and tax-exempt bonds or bond funds to lower your AGI.
- Monitor the timing of certain payments. For example, although prepayment of property taxes or property and local income taxes can save on ordinary tax, it can be expensive if it is subject to AMT. So do not pay your 2020 real estate bill in 2019 in order to get a small discount for early payment if this triggers or increases the AMT’s liability for 2019.
- Take tax credits. You can offset any AMT obligation with non-refundable personal tax credits, such as the dependent credit and the foreign tax credit. You may also be eligible for a minimum tax credit if you have paid AMT in previous years.
The bottom line
Calculating your AMT, or even determining if you are indeed subject to it, is complicated. This article is only an introduction to the topic and cannot give you a full understanding of AMT and how it affects your taxes. Unless you are an expert in tax return preparation and you fully understand how the AMT works, it may be advisable to have your tax return prepared, or at least revised, by an expert tax specialist who will be able to determine if you need AMT, are eligible for exemptions and can claim AMT credits for any year, including previous years.