What Is the Alternative Minimum Tax?
Definition and Examples of the Alternative Minimum Tax
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 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 this, but the income threshold at which the AMT kicked in wasn't initially indexed for inflation and this 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.
What Is the Alternative Minimum Tax?
The Alternative Minimum Tax is intended 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). They must pay the tax if the Alternative Minimum Tax calculation results are more than what whey would otherwise owe in that tax year.
There are two AMT tax rates as of tax year 2019, the return you'll file in 2020—26% and 28%. The "remainder amount," what's left after you calculate your Alternative Minimum Tax income and subtract an exemption amount that you're entitled to, is subject to this tax. It's then multiplied against one of the two AMT tax rates.
The original exemption amount in 1969 was $20,000. Someone who earned that much was pretty comfortable at that time, but $20,000 is equal to more than $143,607 in 2020 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 yearly to keep pace with Americans' earnings. If you were never subject to the AMT before, it's unlikely that your annual pay raise will push you over the limit from one year to the next, but some taxpayers still fall into a gray area.
The Tax Cuts and Jobs Act (TCJA) additionally changed the exemption and phaseout figures in 2018. The exemption was increased to $70,300 for single filers in tax year 2018, and to $71,700 in tax year 2019, the return you'll file in 2020. The phaseouts for these taxpayers—the point at which your exemption amount begins shrinking—were adjusted to $500,000 and $510,300 respectively.
- Alternate name: "Mini" Tax
- Acronym: AMT
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 to claim. This results in your adjusted gross income or AGI.
You must then add back some of those deductions and adjustments to income to arrive at your Alternative Minimum Tax income.
If your AMT income comes out to $74,000, this is more than the $71,700 exemption amount you would be entitled to if you were an unmarried taxpayer in 2019. You would be $3,300 over the threshold, so your AMT would be 26% of this amount—an additional $858 over your regular tax bill.
The 26% AMT tax bracket ends and the 28% AMT tax bracket begins at AMT incomes of $194,800 in tax year 2019 for all taxpayers except those who are married and file separate returns. It kicks in at just $97,400 for married separate filers.
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.
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, as well as any personal exemptions you could claim through 2017 before TCJA eliminated them from the tax code. This is the amount you'd normally use to find out what percentage you owe the IRS.
But 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 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:
- State and local taxes (an itemized deduction that includes property taxes)
- Medical expenses (an itemized deduction)
- Mortgage interest on home equity debt
- Accelerated depreciation
It used to be that itemized miscellaneous deductions had to be added back as well, but the TCJA eliminates most miscellaneous deductions as of 2018. Adding these deductions back becomes unnecessary because nobody's getting this tax break anymore.
Some types of income that are normally not taxable become taxable for purposes of calculating your AMT 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.
Do I Need to Pay the AMT?
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 tax, property tax, home equity interest, and income from incentive stock options are the main causes.
- The Alternative Minimum Tax (AMT) was first designed in 1969 to prevent wealthier taxpayers from making such excessive use of available tax deductions that they were effectively able to reduce their tax liability to zero.
- The AMT requires that taxpayers over certain income thresholds must calculate their income tax the usual way and again under AMT rules and pay whichever results in the higher tax due.
- The tax was not initially indexed for inflation, so it began pinching some middle-income taxpayers as well, something it was never intended to do. Additional legislation has largely fixed this problem.
Tax Policy Center. "Key Elements of the U.S. Tax System." Accessed July 10, 2020.
IRS. "Topic No. 556 Alternative Minimum Tax." Accessed July 7, 2020.
U.S. Congress. "H.R.8 - American Taxpayer Relief Act of 2012." Accessed July 7, 2020.
U.S. Congress. "Individual Tax Reform," Pages 59–61. Accessed July 7, 2020.
Tax Foundation.org. "2019 Tax Brackets." Accessed July 10, 2020.
IRS. "Form 6251, Alternative Minimum Tax—Individuals." Page 2. Accessed July 7, 2020.