What Is the Alternative Minimum Tax?

Woman at laptop calculating her Alternative Minimum Tax
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DEFINITION
The alternative minimum tax is an alternate method of calculating income tax liability. It takes away some common deductions to arrive at a taxpayer's alternative minimum tax income. 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 Alternative Minimum Tax methodology, and pay whichever is more.

The alternative minimum tax (AMT) is an alternate method of calculating income tax liability. It takes away some common deductions to arrive at a taxpayer's alternative minimum tax income.

To understand how and why the alternative minimum tax works the way that it does, it will help to understand a bit of history behind the policy and to see a few examples in action.

Definition and Examples of the Alternative Minimum Tax

Though the alternative minimum tax (AMT) is an alternate method of calculating income tax liability, the "minimum" aspect is something of a misnomer—a taxpayer must calculate their taxable income both ways, once according to ordinary Internal Revenue Code rules, and then again using the alternative minimum tax methodology, and pay whichever is more.

The alternative minimum tax is intended to prevent wealthier taxpayers from slashing their taxable incomes to a bare minimum by using all of the deductions that are available under the IRC. They must pay the tax if the alternative minimum tax calculation results are more than what they would otherwise owe in that tax year. 

  • Alternate name: "Mini" Tax
  • Acronym: AMT

There are two AMT tax rates for tax year 2021, the return you'll file in 2022: 26% and 28%. The "remainder amount" that's left after you calculate your AMT income and subtract an exemption amount that you're entitled to is subject to this tax. It's then multiplied by one of the two AMT tax rates.

The exemption amount for the Alternative Minimum Tax is adjusted for inflation, so it is subject to change each year and set prior to the filing period.

How Does the Alternative Minimum Tax Work?

Both your regular tax and AMT calculations begin at the same place, with your total income as it's entered on your 1040 tax return. You would then subtract various adjustments to income on Form 1040, including deductions that you don't have to itemize in order to claim. This results in your adjusted gross income, or AGI.

You must then add back some of those deductions and adjustments to income, using a different form, to arrive at your alternative minimum tax income.

Suppose that after this process, your AMT income were to come out to $75,000, which is more than the $73,600 exemption amount you would be entitled to if you were an unmarried taxpayer in 2021. You would be $1,400 over the threshold, so your AMT would be 26% of this amount—an additional $364 over your regular tax bill.

The 26% AMT tax bracket ends, and the 28% AMT tax bracket begins, at AMT incomes of $197,900 in the 2021 tax year for all taxpayers except those who are married and file separate returns. It kicks in at just $98,950 for those who are married and filing separately. 

The AMT exemption functions something like a standard deduction. Instead of all the deductions and other adjustments that are taken away when calculating their AMT incomes, taxpayers can reduce their AMT income by claiming the exemption amount for their filing status instead.

The exemption amount begins phasing out by 25 cents per $1 between your AMT income 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.

Notable Happenings

The U.S. Secretary of the Treasury realized in 1969 that some taxpayers who earned well into six figures didn't pay any 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 to prevent that, but the income threshold at which the AMT kicked in wasn't initially indexed for inflation, and that caused some problems.

The tax thresholds remained the same year after year, so more and more middle-income taxpayers found themselves subject to it as years went by, and their incomes increased. They earned incrementally more due to inflation, but the threshold remained stagnant.

The original exemption amount in 1969 was $30,000. That $30,000 is equal to more than $237,750.84 in 2022 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 AMT exemption was finally indexed for inflation when the American Taxpayer Relief Act (ATRA) went into effect in January 2013. It increases a bit every year to keep pace with Americans' earnings. If you were never subject to the AMT before, it's unlikely that a modest annual pay raise would push you over the limit from one year to the next, but some taxpayers may fall into a gray area.

In 2018, the Tax Cuts and Jobs Act (TCJA) went into effect and further reduced the impact of the alternative minimum tax by changing the exemption and phaseout figures. The exemption was increased. It's now $73,600 for single filers in 2021 and $114,600 for married couples. The phaseouts for these taxpayers for 2021—the point at which your exemption amount begins shrinking—are $523,600 and $1,047,200, respectively. In 2017, the last year before the TCJA took effect, a single filer had an exemption of $54,300 and a phaseout threshold of $120,700.

How to Calculate the AMT

For regular tax calculations, you would subtract either the standard deduction or the total of your itemized deductions from your overall income to arrive at your taxable income. (Personal exemptions were suspended from 2018 through 2025 by the TCJA.) This is the amount you'd normally use to find out what percentage you owe the IRS.

However, the taxable income for AMT purposes doesn't allow certain adjustments to income and certain itemized deductions, so your income could jump significantly if you weren't able to subtract all of these items. The resulting number is the AMT income figure that determines whether you have to pay the AMT because your income is over the inflation-adjusted threshold.

The following expenses are not deductible when calculating the AMT, even though you can deduct them when you're calculating your regular tax liability:

  • State and local taxes (an itemized deduction that includes property taxes)
  • Mortgage interest on home equity debt
  • Accelerated depreciation

Some types of income that are normally not taxable become taxable for purposes of calculating your AMT, as well. For example:

  • 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.

Do I Need to Pay the AMT?

The IRS provides a fairly simple worksheet in its Instructions for Form 1040 that you can use to determine whether 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. If it turns out that you're subject to the AMT, you might want to review the actual tax form to understand which income sources or deductions are causing your AMT liability. Many taxpayers find that deductions for state tax, property tax, home equity interest, and income from incentive stock options are the main causes.

Key Takeaways

  • The alternative minimum tax (AMT) was first designed in 1969 to prevent wealthier taxpayers from deducting their tax liability away to zero.
  • The AMT requires that taxpayers over certain income thresholds calculate their income tax both ways and pay the higher tax due.
  • The AMT was later indexed for inflation to keep it from pinching some middle-income taxpayers.
  • Calculating AMT uses a slightly different method to arrive at taxable income, largely eliminating certain deductions.

Article Sources

  1. Internal Revenue Service. "Topic No. 556 Alternative Minimum Tax."

  2. Internal Revenue Service. "Instructions for Form 6251," See 'Line 39'.

  3. Tax Policy Center. "Key Elements of the U.S. Tax System."

  4. Internal Revenue Service. "Instructions for Form 6251."

  5. Tax Foundation. "Backgrounder on the Individual Alternative Minimum Tax (AMT)."

  6. Bureau of Labor Statistics. "CPI Inflation Calculator."

  7. Tax Policy Center. "What Did the American Taxpayer Relief Act of 2012 Do?"

  8. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2021."

  9. Tax Policy Center. "How Did the TCJA Change the AMT?"

  10. Internal Revenue Service. "Tax Reform Basics for Individuals and Families," Page 7.

  11. TurboTax. "Alternative Minimum Tax: Common Questions."