What is Alternative Minimum Tax?
Did you know that when you reach a certain level of income a parallel tax system may apply to your taxes? This separate tax structure, called the alternative minimum tax (AMT), catches some taxpayers by surprise and, frankly, it can be confusing. In addition, recent tax laws have made it less common to take by taxpayers.
Yet, if you’re encountering the alternative minimum tax for the first time, you’ll want to understand the basics as it might be beneficial to you. In this post, we’ll outline the essentials – including why the AMT exists and if you are exempt from it.
What is AMT?
Let’s start by answering, “what is AMT?” As the name suggests, the AMT is a different way of calculating income taxes. Different, that is, from the “regular” way of calculating tax.
At a high level, here’s the deal: if you’re subject to the AMT, you end up calculating your taxes using two methods. If the AMT method results in a higher tax bill, you’ll pay the higher tax.
The AMT also has its own set of rules for income, exemptions, and deductions which we’ll cover here.
History of AMT tax
The AMT tax began as a way to keep wealthy taxpayers from using deductions to avoid paying income tax. The AMT’s purpose is to ensure every taxpayer pays a minimum amount of tax. The latest changes for the AMT came in 2017 with the Tax Cuts and Jobs Act (TCJA). Starting in 2018, the TCJA greatly increased AMT exemptions and exemption phaseout thresholds. For instance, the phaseout threshold for a single filer increased from $120,700 in 2017 to $500,000 in 2018, so it quadrupled.
(AMT exemptions and phaseout thresholds for 2020 are shown below.)
These and other changes made by the TCJA are in place temporarily through 2025, and truthfully, had the effect of greatly reducing the number of taxpayers who pay AMT. According to IRS statistics, the number of taxpayers who paid AMT dropped from over 5 million in 2017 to under 250,000 in 2018.
How is AMT calculated?
The AMT starts with regular taxable income and applies its own system of “adjustments” and “preferences.” These are calculations that add more income to or remove deductions from regular taxable income to arrive at alternative minimum taxable income (AMTI). In some ways, you can say that the AMT causes you to “lose” some tax breaks. Next, an AMT exemption is subtracted, and AMT tax rates are applied to get to tentative minimum tax.
In the AMT parallel tax system, you must:
- Complete your regular tax return.
- Complete AMT Form 6251.
- Compare the two taxes.
- Pay the higher of the two taxes.
There’s no easy way to see if you’re subject to the AMT. However, you could be subject to it if you:
- Claim certain itemized deductions on your Schedule A
- Exercise incentive stock options (ISOs) but don’t sell the stock in the same year
- Have interest income from certain private activity bonds
Also, different AMT calculations may apply to net operating losses, depreciation, passive activity losses, and many other tax items.
After adjustment and preference items are added or subtracted, you’re left with alternative minimum taxable income, or AMTI. Next you apply the AMT exemption. Your AMTI and your filing status determine your exemption amount. Exemption amounts for 2020 are:
- Married filing jointly or qualified widow(er) — $113,400
- Single or head of household — $72,900
- Married filing separately — $56,700
For 2020, the exemption amounts are phased out at the rate of 25 cents for each $1 of AMT income more than:
- Married filing jointly or qualified widow(er) — $1,036,800
- Single or head of household — $518,400
- Married filing separately — $518,400
After you subtract the exemption amount from AMTI, the remaining income will be subject to the AMT rate. The AMT rate is a flat 26% for income up to $197,900 ($98,950 for married taxpayers filing separate returns). Income more than those amounts is taxed at a rate of 28%. Special calculations apply to capital gains.
As explained earlier, because of the exemption and phaseout threshold increases, fewer taxpayers end up of paying AMT today, even if some of the preference or adjustment items apply to them.
Thanks to another tax law change (the 2019 “SECURE” Act), children who are subject to the “According to IRS statistics” use the same AMT exemption as other taxpayers. Before this change, the exemption amount was much lower than the regular exemption. For instance, the exemption was $7,500 in 2017. That meant children with investment income frequently paid AMT as well as regular tax. Children who pay kiddie tax on investment income are far less likely to pay AMT. This change is effective through 2025.
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