What Is the Alternative Minimum Tax and Do You Owe It?
Understanding the Alternative Minimum Tax
The Alternative Minimum Tax (AMT) is an alternate method of calculating tax liability. In theory, it's supposed to prevent wealthier taxpayers from slashing their taxable incomes to a bare minimum by using all the deductions that are available under the Internal Revenue Code (IRC). In reality, the AMT can hit some middle-income taxpayers, too.
The tax takes away some common deductions to arrive at a taxpayer's alternative minimum tax income (AMTI). The "minimum" aspect is something of a misnomer—a taxpayer must calculate their taxable income both ways, once according to ordinary IRC rules, then again using the AMTI methodology. They must pay the AMT if the AMTI calculation results are more than that year's exemption amount.
The Initial Problem
Back in 1969, the U.S. Secretary of the Treasury realized that some taxpayers who earned well into six figures (in 1960s dollars) did not pay any income tax at all. They avoided it by claiming so many tax deductions that they were effectively erasing their incomes. The AMT was signed into law a year later to prevent this, but the income threshold at which the AMT kicked in wasn't indexed for inflation back then. It remained the same year after year, and more and more middle-income taxpayers found themselves subject to the tax as years went by. They earned incrementally more, but the threshold remained stagnant.
Someone who earned $20,000 in 1969 was pretty comfortable, but not today; that $20,000 is equal to more than $143,607 in 2020 dollars after adjusting for inflation. The tax began hitting the middle class as well as the upper class as time went by, and it was not originally intended to do that.
The American Taxpayer Relief Act
The AMT threshold was finally indexed for inflation when the American Taxpayer Relief Act (ATRA) went into effect in January 2013. It now increases a bit yearly to keep pace with Americans' earnings. If you were never subject to the AMT, it's unlikely that your annual pay raise will push you over the limit from one year to the next.
However, some taxpayers still fall into a gray area. You could find yourself liable for the AMT in any given tax year if your income is such that you've been teetering the line from year to year between having to pay the AMT or dodging it, and your income increases by more than the annual inflation adjustment.
Phaseouts and Exemptions
The AMT exemption functions something like a standard deduction for the alternative minimum tax. Instead of all the deductions and other adjustments that are taken away when calculating AMTI, taxpayers can reduce their AMT income by claiming the exemption amount for their filing status instead. If your income exceeds the exemption amount for your filing status, you're subject to the AMT—which is calculated on what's left after the exemption has been subtracted.
However, the exemption amount begins phasing out by 25 cents per $1 between your AMTI and the phaseout threshold amount. The phaseout is completed, and the exemption amount is reduced to zero when your AMT income reaches four times the exemption amount plus the phaseout threshold.
The Tax Cuts and Jobs Act (TCJA) changed up the exemption and phaseout figures when it came along in 2018. The exemption increased to $70,300 for single filers in tax year 2018, and $71,700 in tax year 2019, and phaseouts for these taxpayers—the point at which your exemption amount begins shrinking—adjusted to $500,000 and $510,300, respectively. The exemption amount for married taxpayers who file joint returns was upped to $109,400, then to $111,700 for tax year 2019 to keep pace with inflation, and the phaseout of $1 million increased to $1.02 million in tax year 2019.
Calculating Your AMT Income
Let's imagine that you're single, and your AMTI comes out to $75,000 after adding back disallowed deductions; you would be subject to the AMT. Both your regular tax and AMT calculations begin at the same place, with your total income as entered on your 1040 tax return. You would then subtract various adjustments to income on your 1040, including deductions that you don't have to itemize to claim. This results in your adjusted gross income or AGI.
From here, the AMT and regular tax calculations part ways. For regular income tax, you would then subtract either the standard deduction or the total of your itemized deductions from your AGI, as well as any personal exemptions you could claim, at least through 2017. The TCJA eliminated personal exemptions beginning in 2018 through at least 2025. The result is your regular taxable income.
This taxable income figure is the amount you'd normally use to look up the tax liability figures—your tax bracket—in the tax tables to find out what percentage you owe the IRS. However, the taxable income for AMT purposes does not allow certain adjustments to income and certain itemized deductions. Your income could jump significantly if you weren't able to subtract all these items, and the resulting number is the AMTI figure that determines whether you have to pay the AMT because your income is over the inflation-adjusted threshold.
Affected Itemized Deductions
The following expenses are not deductible when you're calculating your AMT income, even though you can deduct them when you're calculating your regular tax. They reflect the typical adjustments that most taxpayers are subject to, but if you have a lot of significant deductions in these categories, it can trigger an AMT liability:
- State and local income taxes (an itemized deduction that includes property taxes)
- Medical expenses (an itemized deduction)
- Mortgage interest on home equity debt
- Accelerated depreciation
Here's where the TCJA affects the AMT again. It used to be that itemized miscellaneous deductions had to be added back to your income as well when calculating your AMTI, but the new tax law eliminates most miscellaneous deductions as of 2018. Adding these deductions back to your income becomes unnecessary because nobody's getting this tax break anymore.
Other AMT Adjustments
Some types of income that are normally not taxable become taxable for purposes of calculating your AMTI as well. You must include the difference between the fair market value of incentive stock options and their strike price if the options are exercised and remain unsold at the end of the year. You must also include otherwise tax-exempt interest from private activity bonds, the foreign tax credit, passive income and losses, and the net operating loss deduction.
AMT Tax Rates
There are two AMT tax rates as of tax year 2019: 26% and 28%. The "remainder amount"—which is the amount that's left after you calculate your AMTI and subtract the exemption amount you're entitled to—is subject to this tax. It's then multiplied against one of the AMT tax rates.
If you're single and your AMTI comes out to $74,000, you would be $3,300 over the threshold, so your AMT is 26% of this amount—an additional $858 over your regular tax bill. In tax year 2019, the 26% AMT tax bracket ends and the 28% AMT tax bracket begins at AMTIs of $194,800 for all taxpayers except those who are married and file separate returns. It kicks in at just $97,400 for married separate filers.
Check to See If You're Subject to the AMT
The Internal Revenue Service provides a fairly quick worksheet in its Instructions for Form 1040, which you can use to determine if you have to fill out the longer Form 6251 to compute your alternative minimum tax. Most tax software programs compute the AMT for you automatically. Still, you might want to review the actual tax form anyway to understand which income or deductions are causing your AMT liability if it turns out that you're subject to the tax. Many taxpayers find that deductions for state income tax, property tax, home equity interest, and income from incentive stock options are the main causes.
IRS. "Topic No. 556 Alternative Minimum Tax." Accessed Feb. 14, 2020.
Tax Policy Center. "Key Elements of the U.S. Tax System." Accessed Feb. 14, 2020.
Congress. "H.R.8 - American Taxpayer Relief Act of 2012." Accessed Feb. 14, 2020.
Congress. "Individual Tax Reform," Pages 59–61. Accessed Feb. 14, 2020.
IRS. "1040 and 1040-SR," Page 6. Accessed Feb. 14, 2020.
IRS. "Form 6251, Alternative Minimum Tax—Individuals," Page 2. Accessed Feb. 14, 2020.