What is AMT & Why Do I Have to Pay it?
The federal income tax system is meant to be fair and progressive. To make sure everyone is paying a fair amount of income tax, and not reducing their tax bill too low, an “alternate” system called alternative minimum tax (AMT) was created.
If your regular tax is higher than what is calculated under the AMT system, you do not owe AMT. However, if your regular tax is less than what is calculated under the AMT system, you will find an additional tax calculated under the “alternate” system. Form 6251, Alternative Minimum Tax – Individuals, is used to calculate AMT.
The regular tax system has progressive rates, meaning those who can pay more, because of higher earnings, will pay more. The more you make, the higher your tax rate. But you don’t lose the benefit of the lower rates. Once your income moves into the next rate, only that portion of your income will be taxed based at that higher rate.
To determine how much income is subject to AMT, alternative minimum taxable income is calculated by adding back certain items that are allowed to reduce taxable income under the regular tax system but are not allowed for AMT. Once alternative minimum taxable income is determined, an exemption amount may further reduce that income subject to the AMT rates
Not all taxpayers receive a benefit for the exemption amount because the AMT exemption is reduced by 25% of the amount by which the alternative minimum taxable income exceeds the beginning phase-out amount and completely phased-out when your income reaches that ending phase-out.
Is There Any Hope?
It may have come as a shock to find out you now have to pay more because of the AMT system. Does this mean that all tax planning is a lost cause now that you are subject to the AMT system? Absolutely not.
These items may lower both regular and AMT taxes:
- Capital gain rates.
- Business losses.
- Items that reduce adjusted gross income, such as deductible IRA contributions, deductible moving expenses, student loan interest, qualified educator expenses, etc.
Several popular itemized deductions are still allowed regardless of AMT:
- Charitable contributions.
- Mortgage interest on acquisition costs, home improvements and construction of a home as well as a second home. The second home is defined less liberally for AMT purposes; for example it does not include a boat or motorhome.
- Medical expenses that exceed 10% of your adjusted gross income.
- Casualty losses.
Unfortunately, these common items do not provide benefits within the AMT system:
- Personal exemptions.
- Standard deduction (if you don’t itemize, this is added back).
- Property taxes.
- State income tax paid (if you itemize).
- Miscellaneous itemized deductions subject to the 2% AGI.
- The deferral of income from the exercise of ISOs.
Potential Credit for These Taxes
You may be able to obtain a credit for your prior year(s) minimum tax that you paid. Form 8801, Credit for Prior Year Minimum Tax, is used to calculate the credit. The calculation of this credit is complicated and depending on what caused your AMT, you may get some, all or none of the AMT paid as a credit. Discuss this with your tax professional.