What Is the Alternative Minimum Tax?
Understanding the Alternative Minimum Tax
The Alternative Minimum Tax, familiarly known as the AMT, is an alternate method of calculating tax liability. In theory, it's designed to prevent wealthier taxpayers from slashing their tax debts to a bare minimum by using all the deductions that are available under the regular tax rules.
It effectively takes away some of those deductions so these individuals pay taxes on more income. That's the "alternative" part.
The "minimum" aspect is something of a misnomer—the taxpayer actually pays whichever of the two tax calculations comes out to be more and that's usually the AMT.
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 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.
The income threshold at which the AMT started to kick in was not indexed for inflation back then. This meant that it remained the same year after year. Because the threshold was stagnant, more and more middle class taxpayers found themselves subject to the AMT as years went by.
Think about it: How much did $200,000 buy in 1970 and how much does it buy today? Someone who earned $20,000 in 1970 was very comfortable.
Today? Not as much. The tax began hitting the middle class as well as the upper class as time passed, and it was never intended to do that.
The American Taxpayer Relief Act
This all changed when the American Taxpayer Relief Act (ATRA) went into effect in January 2013. The threshold was finally indexed for inflation so now it inches upward incrementally year by year to keep pace with inflation.
If you were never subject to the AMT to begin with, it became unlikely that your annual well-deserved pay raise would push you over the limit. If you became a rock star overnight and your income suddenly doubled, however, you would find yourself dealing with this tax.
Some taxpayers still fall into a gray area. 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, you could find yourself liable for the AMT in any given tax year if your income increases by more than the annual inflation adjustment.
AMT Exemption Amounts and Phase-Outs for 2017
This is how it worked out in 2017. The "exemption amount" is the threshold that was finally indexed for inflation.
AMT Exemption Amounts and Phase-Outs for 2017
The exemption amount is phased out starting at AMTI of:
The exemption amount is fully phased out by AMTI of:
|Head of Household||54,300||120,700||337,900|
|Married Filing Separately||42,250||80,450||249,450|
|Married Filing Jointly||84,500||160,900||498,900|
The Tax Cuts and Jobs Act
Then, effective 2018, along came the Tax Cuts and Jobs Act (TCJA) and the AMT was changed again.
The exemption amount for married taxpayers who file jointly was raised to $109,400 with a phaseout of $1 million. It was increased to $70,300 for single filers with a phaseout of $500,000. These exemption figures include the adjustments for inflation.
The TCJA also affected numerous other tax provisions, some of which are directly involved in calculating the AMT.
What the Phaseout Means
The exemption amount functions something like a standard deduction for the AMT. In lieu of all the disallowed deductions and other adjustments, taxpayers can reduce their alternative minimum tax income by the exemption amount. The alternative minimum tax is calculated on what's left over after the exemption amount has been subtracted.
If you're single in 2018 and your alternative minimum tax income after adding back in disallowed deductions comes out to $80,000, you'll pay the AMT on $9,700.
The exemption amount is reduced or phased out by 25 percent of the difference between a person's alternative minimum tax income and the phase-out threshold amount. The phase-out is therefore completed—meaning the exemption amount is reduced to zero—when AMT income reaches four times the exemption amount plus the phase-out threshold.
Calculating Your AMT Income
Both your regular tax and AMT calculations start at the same place, on page 1 of your Form 1040. This is where your total income is entered.
You could then subtract various adjustments to income to arrive at your regular taxable income, deductions that you don't have to itemize to claim. Some common adjustments in 2018 include a portion of self-employment tax and certain retirement plan contributions. It used to be that you could also deduct any alimony you paid, but the TCJA largely eliminated this adjustment to income.
The result of all this subtracting is 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 also eliminates personal exemptions beginning in 2018.
The result is your regular taxable income. This taxable income figure is the amount you'd use to look up the tax liability figures—your tax bracket—in the tax tables to find out how much you owe the IRS. Those 155 taxpayers back in the sixties managed to more or less reduce this number to zero.
But taxable income for AMT purposes does not allow the standard deduction or certain types of itemized deductions. It also doesn't allow deductions for personal exemptions. As a practical matter, that personal exemption deduction becomes moot with the passage of the TCJA because the new tax law also eliminates this tax perk—no one can claim it regardless of income.
But otherwise, your income could jump significantly if you weren't able to subtract all these things and the resulting number is what 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 for 2017, even though you can deduct them when you're calculating your regular tax:
- State and local income taxes
- Medical expenses
- Miscellaneous deductions such as employee business expenses and investment expenses
- Mortgage interest on home equity debt
- Accelerated depreciation
Here's where the TCJA affects the AMT again. The new tax law also eliminates most miscellaneous deductions as of 2018, so adding this back in to your income becomes unnecessary as well.
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 AMT—wealthy taxpayers can't deduct more than $10,000 in any event.
This list is not comprehensive. It reflects the typical adjustments most taxpayers are subject to. But if you have a lot of significant deductions in these categories, it can trigger an AMT liability.
Other AMT Adjustments
Some types of income that are normally not taxable become taxable for purposes of calculating your income for the AMT. 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 just two AMT tax rates as of 2018: 26 percent and 28 percent. The "remainder amount" is subject to this tax. It's what's left over after constructing the tax base of alternative minimum taxable income and calculating and subtracting the exemption amount. This remainder is multiplied against the AMT tax rates.
For 2017, the threshold where the 26 percent AMT tax bracket ends and the 28 percent AMT tax bracket begins is:
- $93,900 for married filing separately
- $187,800 for all other filing statuses
These percentages are also adjusted in 2018:
- $95,700 for single filers
- $191,500 for those who are married filing jointly
Check to See if You're Subject to the AMT
The Internal Revenue Service has an online calculator to help you figure out if you're subject to the alternative minimum tax. It's called the "AMT Assistant for Individuals".
There's also a fairly quick worksheet in the Instructions for Form 1040. You can use this worksheet to determine if you'll need to fill out the longer Form 6251 to compute your alternative minimum tax.
Most tax software programs will compute the alternative minimum tax automatically, but you might want to review the actual tax form anyway to understand which income or deductions are causing AMT liability. For many taxpayers, deductions for state income tax, property tax and home equity interest and income from incentive stock options are the main causes.