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). That's the "alternative" part. The "minimum" aspect is something of a misnomer—a taxpayer must calculate his taxable income both ways, once according to ordinary IRC rules, then again using the AMTI methodology. He must pay the AMT if the AMTI calculation results is more than that year's exemption amount.
How the AMT Got Such a Bad Reputation
Back in 1969, the U.S. Secretary of the Treasury realized that 155 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 and they earned incrementally more but the threshold remained stagnant.
Think about it. Someone who earned $20,000 in 1969 was pretty comfortable. Today? Not so much. That $20,000 is equal to more than $141,000 in 2019 dollars, adjusting for 50 years of 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 inches upward a little year by year to keep pace with Americans' earnings.
If you were never subject to the AMT to begin with, it's unlikely that your annual well-deserved pay raise will push you over the limit from one year to the next. If you become a rock star overnight and your income suddenly quadruples, you'll find yourself dealing with this tax.
That said, 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 on a tightrope from year to year between having to pay the AMT or dodging it and your income increases by more than the annual inflation adjustment.
AMT Phaseouts and Exemptions
The AMT exemption functions something like a standard deduction for the alternative minimum tax. In lieu 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. Basically, if your income exceeds the exemption amount for your filing status, you're subject to the AMT. The AMT is then calculated on what's left over after the exemption has been subtracted.
But there's a catch. The exemption amount begins reducing or "phasing out" by 25%—25 cents of each dollar or $1 out of every $4—between your AMTI and the phase-out threshold amount. The phase-out is completed and the exemption amount is reduced to zero when your AMT income reaches four times the exemption amount plus the phase-out threshold.
The Effect of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) changed up the exemption and phase-out figures when it came along in 2018. The exemption amount for married taxpayers who file joint returns was upped to $109,400, then to $111,700 in 2019 to keep pace with inflation. The phaseout of $1 million in 2018—the point at which your exemption amount begins shrinking—increased to $1,020,600 in 2019.
The exemption increased to $70,300 for single filers in 2018, and $71,700 in 2019. Phaseouts for these taxpayers adjusted to $500,000 and $510,300 respectively.
Calculating Your AMT Income
If you're single in 2019 and your AMTI, after adding back disallowed deductions, comes out to $75,000, you're subject to the AMT. You're over the exemption amount of $71,700. But how do you calculate your AMTI?
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, deductions that you don't have to itemize to claim, under ordinary IRC tax rules. The result of all this subtracting gives you your adjusted gross income or AGI.
From this point, the AMT and regular tax calculations part ways. For regular income tax, you would next 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.
But 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.
Itemized Deductions That Are Affected
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. This list is not comprehensive. It reflects 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.
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.
State and local taxes are now capped at $10,000 under the TCJA. While this deduction doesn't exactly become moot, it will have less of a negative effect for some for purposes of calculating AMTI because wealthy taxpayers can't deduct more than $10,000 in any event.
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 are also recalculated for AMT purposes.
AMT Tax Rates
There are two AMT tax rates as of 2019: 26% and 28%. The "remainder amount" is subject to this tax. The remainder amount is what's left over after you calculate your AMTI and subtract the exemption amount you're entitled to. It's then multiplied against one of the AMT tax rates.
Remember that example where you're single in 2019 and your AMTI comes out to $75,000? You're $3,300 over your threshold, so your AMT is 25% of this amount, an additional $825 over your regular tax bill.
In 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. You can use this worksheet 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, but 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.