The Alternative Minimum Tax (AMT) is a prime example of how legislation passed in Washington, DC can backfire on the general public.
AMT is best described as a parallel tax category created by Congress to operate alongside traditional federal income tax.
What is the alternative minimum tax?
Alternative Minimum Tax, also known as AMT, is a tax imposed on individuals who earn a certain amount of income on top of their income tax, to ensure that they pay the minimum amount of tax. The idea of the AMT was to ensure that taxpayers of a certain income who took many deductions always paid their fair share of taxes.
The AMT asks certain taxpayers to calculate their tax liability twice – first under established regulations for regular income taxes and a second time to comply with the rules and mandates of the AMT. The AMT increases the amount of income that can be taxed by the federal government.
It does this by recalculating an individual’s income tax after adding certain deductions to the taxpayer’s adjusted gross income. Deductions are included in the taxpayer’s annual income to determine that individual’s alternative minimum taxable income (AMTI). After that, the AMT exemption is subtracted to achieve the individual’s tax obligations to Uncle Sam.
Primarily, the alternative minimum tax impacts high-income Americans who have between $200,000 and $1 million in annual income. Still, US taxpayers earning as little as $75,000 may be trapped in AMT, based on IRS qualifying rules.
The origins of the alternative minimum tax
How could a tax law created by Congress and designed to protect the middle class lead more Main Street taxpayers to a higher tax burden? It’s complicated, but the Alternative Minimum Tax has a long and slightly twisted history since its first introduction in 1969 (known then as the “millionaire’s tax”).
In 1969, 155 wealthier Americans used so many tax breaks, deductions, and other strategies that each of them ended up paying no federal income tax. Congress caught wind of the scheme and eventually instituted a parallel tax to the US tax code, designed to eliminate the kind of tax avoidance strategies deployed by a few high-income Americans.
Thus, the Alternative Minimum Tax was born, and with it, a track record of legislative futility, as more and more middle-class Americans were trapped in the AMT due to a major accounting omission – unlike to traditional income taxes, the AMT was not indexed to inflation when the bill was passed by Congress.
Eventually the omission was corrected and the AMT was indexed to inflation, but that didn’t happen until 2013 when President Barack Obama signed the American Taxpayer Relief Act of 2012. was far too late for the 5.2 million middle class. Americans subject to the alternative minimum tax – up from 200,000 in 1982.
Another key piece of tax legislation – the Tax Cut and Jobs Act of 2017 – included a provision to dramatically increase AMT exemption levels and hopefully bring down the number of Americans subject to tax. ‘AMT at 1982 levels.
Economically, the Alternative Minimum Tax has minimal impact on the US economy. According to IRS figures, AMT collected about $38 billion in taxes in 2017, a small drop in the ocean considering Uncle Sam collected $3.4 trillion in federal taxes in 2017. 2017.
Focus on the IRS form 6251
Taxpayers wondering if they are subject to AMT should complete IRS Form 6251.
If the tax calculated on IRS Form 6251 exceeds the tax liability shown on the regular IRS tax form, you will have to pay the difference, plus any tax due based on your regular IRS tax form. Taxes owed can really add up, as the AMT requires taxpayers to add tax-saving items back into their income, including:
- The deduction for national and local taxes.
- Mortgage interest on home equity.
- Employee business expenses and other miscellaneous deductions.
The alternative minimum tax also comes into effect after adding earned income that is not included in ordinary income tax, including:
- Fair market value of certain stock options exercised but not sold.
- Tax-exempt interest from private activity bonds.
- Foreign tax credits.
- Passive income and losses.
- Deductions for net operating losses.
Other minimum tax exemption levels
Now that the alternative minimum tax adjusts for inflation, the AMT exemptions are higher than before 2013. In 2018, the IRS AMT exemption levels are as follows:
- Single taxpayers: $70,300
- Married taxpayers filing jointly: $109,400
- Groom filing separately: $54,700
Based on the Tax Cut and Jobs Act of 2017, exemptions and phase-out levels will increase from 2018 to 2015, which should reduce the number of Americans exposed to the alternative minimum tax. In fact, the US government estimates that the number of taxpayers exposed to AMT will increase from five million to 200,000 during this period.
If you end up having to pay alternative minimum tax, pay it – there’s really no practical way around it.
What you can do, however, is take specific steps to avoid paying AMT the following year.
You can do this by having your company reimburse you for all AMT taxes paid, not to prepay your property taxes in the current tax year, and to sell all exercised incentive stock options. in the same calendar year that you exercised these options. All exercised stock options that are not sold are considered income by the IRS and subject to AMT.
How to plan for alternative minimum tax
Here are some additional ways to reduce the taxes owed on the alternative minimum tax:
- Increase your contributions to your retirement plan. Any contribution to an employer retirement plan, including a 401(k) plan or a tax-deductible IRA, reduces your gross annual income. This decreases the chances of your qualifying for the AMT.
- Take advantage of a flexible spending account. Paying for medical expenses through a flexible spending account or health savings account, and funding these plans with pre-tax money, can also reduce your gross annual income and make you less likely to pay alternative minimum tax.
- Switch to itemized tax deductions. Instead of calculating your taxes using the standard deduction, switch to itemized tax deductions. Certain itemized deductions are allowable under the AMT.
- Cut off any taxable investment income. To further reduce your annual income and increase your chances of avoiding AMT, reduce your tax liability by making smart investments. For example, you can reap investment losses to offset capital gains realized during the tax year. Large capital gains often push taxpayers into AMT territory, so any means of minimizing them can help you get around the alternative minimum tax.
- Increase your charitable contributions. Increasing your charitable contributions can reduce your annual income and prevent you from triggering AMT.