The Alternative Minimum Tax (AMT) has changed, and it won’t trap as many people as it once did.
The AMT is perhaps the original stealth tax. When it was created in 1969, it was intended for wealthy individuals who used numerous tax breaks to avoid paying income tax. But Congress didn’t adjust the AMT because other parts of the tax code changed. The result was that the AMT would trap many middle-class taxpayers, especially retirees, who would have already paid substantial taxes in ordinary income tax. They paid more under the AMT.
The AMT is a second tax regime. You calculate your regular income tax. Then you also calculate tax under the AMT by adding back any relevant tax relief, known as tax preferences, to your regular taxable income. AMT’s taxable income is subject to only two tax rates. A 26% rate is paid on the first $191,000 of AMT taxable income and a 28% rate on higher AMT taxable income.
The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, significantly changed the AMT. About 5 million taxpayers had to pay AMT under the old law, but only 200,000 are expected to pay AMT this year. So few taxpayers will need the AMT that the IRS says it will remove its AMT Assistant online tax tool.
Three key changes in the TCJA have returned the AMT to being primarily a millionaire’s tax.
First, the AMT exemption has been significantly increased. For married taxpayers filing jointly, the exemption is $109,400 in 2018. It is $70,300 for singles and heads of families, and the exemption is $54,700 for married taxpayers filing separately. These exemptions compare to $84,000, $54,300 and $42,250, respectively, for 2017.
Second, the income levels at which the exemptions are phased out are much higher. They are $1 million for married couples filing jointly and $500,000 for other taxpayers. In 2017, the elimination levels were $160,900 and $120,700 respectively.
Third, many of the tax breaks that triggered the AMT for middle-class taxpayers have been changed. Middle-income taxpayers were frequently subject to AMT when they received high levels of personal and dependent exemptions, deductions for various itemized expenses, mortgage interest on home equity, and state and local tax deductions. Personal exemptions are eliminated (although dependent exemptions remain), as are miscellaneous itemized expenses and the home equity interest deduction. The state and local tax deduction is limited to $10,000 per tax return. Collectively, they are replaced by a much higher standard deduction.
The combination of these changes means that you must have many tax preference items to trigger AMT. In the past, because the exemption amount was so low, a slightly higher than average amount of preference items would push a taxpayer toward AMT.
A number of tax preference elements remain. They will be listed on IRS Form 6251 and its instructions. Incentive stock options remain a key AMT trigger for many employees of companies that use them as compensation. Other major preference items are standard deduction, certain net operating losses, certain types of accelerated depreciation, and interest on tax-exempt private activity bonds. A significant amount of long-term capital gains can also trigger AMT, as can having a lot of dependents.
As before, the AMT is so complicated that it is not possible to give general rules about who is at risk. The trigger varies depending on your usual tax bracket and the amount of tax benefits you have. The higher your income, the more preference items you need to trigger AMT. Also, due to some nuances in the interaction between ordinary income tax and AMT, single taxpayers are somewhat less likely to trigger AMT than married taxpayers filing jointly.
You need to estimate your taxes back and forth during the year to determine if you could trigger AMT. Use the results to plan your trades for the rest of the year.
As with many other provisions of the 2017 tax law, the changes to the AMT are scheduled to expire after 2025.