Understanding the Dreaded Alternative Minimum Tax
As if figuring out how much you owe in taxes weren’t complicated enough, the government actually makes you figure it out two separate ways. Welcome to the head-scratching world of the Alternative Minimum Tax (AMT).
Although it was originally created to target only the ultra-wealthy who benefited from unusual tax benefits, the AMT has become decidedly more egalitarian in recent years and now affects many middle-class taxpayers. The thought of being hit by the AMT might send chills up your spine, but the more you know about it, the less scary it seems.
Where did the AMT come from?
Congress created the AMT in 1969 as a way to ensure that high-income taxpayers were not able to completely avoid paying taxes thanks to extensive use of deductions, credits, and loopholes in the tax code. But the AMT system, which affected only a sliver of U.S. taxpayers in its first year, continually expands its reach because the amounts used to calculate the AMT are not automatically indexed to inflation. In 2011 an estimated 4.3 million Americans had to pay the AMT.
How does it work?
The AMT is a parallel tax system to the regular income tax. You essentially have to calculate your tax bill under both systems and then pay whichever one is higher. The primary difference between the two systems is that the AMT does not allow many of the common deductions or income exceptions found in the regular system.
Here is a high-level look at how the AMT is calculated:
Start with your Adjusted Gross Income as determined under the regular tax system
Add back the standard deductions for yourself and your dependents
Add back the itemized deductions that are either eliminated or reduced under the AMT, such as deductions for state and local income and property taxes, some medical expenses, interest on a home-equity loan (in some instances), and employee business expenses
Add income that was not counted as taxable income under the standard system, including interest from private-activity bonds and unrealized gains from incentive stock options granted by your employer
Add or subtract any remaining AMT preference items
Subtract the AMT exemption amount to determine the amount of income you have that is subject to the AMT; for 2012, the AMT exemption is $78,750 for joint filers and $50,600 for single filers, but these exemption amounts are reduced by 25 cents for each dollar of AMT income above $150,000 for couples and $112,500 for singles
Calculate your AMT tax at 26% of the first $175,000 of AMT taxable income and 28% on the remainder of AMT taxable income
What are some common AMT triggers?
Claiming the following deductions, credits, or types of income for your regular income tax can increase the likelihood that you will be subject to the AMT:
Personal deductions for multiple dependents
Itemized deductions for state and local taxes, medical expenses, unreimbursed employee expenses, and other miscellaneous expenses
Mortgage interest on home equity debt
Accelerated depreciation
Exercising (but not selling) incentive stock options
Tax-exempt interest from private activity bonds
Passive income or losses
Net operating loss deduction
Foreign tax credits
Investment expenses
What can I do to lessen the impact of the AMT?
By now you may be asking if there is any way to get around the AMT altogether. Because it adjusts for various deductions and credits, there is not a whole lot you can do to dodge the AMT. But planning ahead can help keep your AMT adjustments low.
Seek reimbursements from your employer for business expenses incurred.Unreimbursed expenses incurred by employees are one of the itemized deductions not allowed under the AMT.
Review your state tax withholding and make sure to pay in enough so you don’t owe, but not so much that you overpay. This will keep your state tax deduction as low as possible.
Pay your property taxes close to the due date instead of prepaying; this will keep your deduction for state and local taxes as low as possible.
Sell incentive stock options in the same year you exercise them. By exercising and selling options in the same year, you’ll be subject to the regular tax on the income but not the AMT.
How did the fiscal cliff deal affect the AMT?
The last-minute deal struck by Congress to avoid the fiscal cliff on January 1, the American Taxpayer Relief Act, permanently extends the AMT “patch” and makes it retroactive to January 1, 2012. It used to be that Congress would have to scramble each December to renew the AMT “patch” to prevent the AMT from affecting millions of additional middle-class taxpayers. But now that the “patch” has been made permanent and indexed for inflation, we don’t have to worry about this annual drama.
How can I tell if I will be subject to the AMT?
For clients of Eilts & Associates, we calculate both your regular tax and your AMT, so we will let you know what you owe under both systems. There are also several online tools that can help you determine if you are subject to the AMT. The Internal Revenue Service has an online calculator called the AMT Assistant for Individuals.
I hope this article helped answer some of your questions about the AMT and, in process, made it a little less scary. If you have any questions, please contact Bart Eilts at 773.525.6171 or bart@eiltscpa.com.
