Understanding the Alternative Minimum Tax AMT is very important for higher income taxpayers and other taxpayers who might fund themselves in situations where the AMT might apply. The tax law gives special treatment to certain kinds of income and allows special deductions for certain kinds of expenses. Congress eventually determined that not all taxpayers are situated equally and that certain taxpayers should be denied this deduction. Depending on the amount of your “taxable excess,” AMT rates ranging from 26 to 28 percent may be imposed on tax preference and adjustment items. In view of the serious risk of AMT exposure, careful planning to reduce your overall tax bill is critical.
What is the Alternative Minimum Tax (AMT)?
The Alternative Minimum Tax (AMT) was designed to increase the tax bill of taxpayers who take undue advantage of these tax benefits to lower their tax bills. The basic mechanism by which the AMT accomplishes its objective is by treating certain items less favorably than they are treated for purposes of the regular tax. In the AMT legislation, These items are referred to as “tax preferences” or “adjustments.” The AMT operates parallel to the regular tax and sets a floor on total tax liability. Taxpayers whose income exceeds the AMT exemption must calculate both regular tax and AMT liabilities and pay the larger amount.
Overview of Alternative Minimum Tax AMT for Individuals
Adjustments differ from preferences only in that adjustments involve a substitution of a special AMT treatment of an item for the regular tax treatment (for example, no deduction is allowed for personal and dependency exemptions), while a preference generally involves the addition of the difference between the special AMT treatment and the regular tax treatment (for example, depletion is limited to the adjusted basis of the property).
Tax deductions and exemptions disallowed with AMT
Under AMT rules, you still start with your gross income, but many of the usual deductions and exemptions are disallowed. Suddenly, your taxable income is a lot higher. The AMT starts with your regular taxable income and, in general, makes you “give back” the tax preferences and adjustments until you arrive at “alternative minimum taxable income” (AMTI). Then, after subtracting an exemption amount (discussed below), a tax rate of 26% applies to the first $182,500 in 2014 (and the first $179,500 in 2013) of this income and 28% to amounts above $182,500 in 2014 (and above $179,500 in 2013). For married taxpayers who file separately, the rate changes at $91,250 in 2014 (and $89,750 in 2013). However, the AMT rates for long-term capital gains, as well as dividends that qualify to be taxed at long-term capital gain rates, are the same favorable rates that apply for regular tax purposes.
Who Pays the Alternative Minimum AMT Tax?
The number of taxpayers owing the AMT grew from about 20,000 in 1970 to roughly 4.3 million in 2011. TPC projects that there will be 3.9 million AMT taxpayers in 2013. Taxpayers do not owe AMT if their AMTI is less than the relevant AMT exemption ($51,900 for single taxpayers and $80,800 for married taxpayers in 2013). If AMTI exceeds those amounts, taxpayers must calculate their tentative AMT liability to see if they owe the additional tax.
What to do if subjected to the AMT?
You may be subjected to the AMT even if you have no tax preferences. For example, if you have a large family, elimination of the personal and dependency exemptions to which you are entitled for regular tax purposes may cause you to be subject to the AMT. You compute the AMT on a special IRS form (Form 6251) that must be attached to your Form 1040. Adjustments and preferences.
Common Adjustments or Preferences for AMTI
- Tax-exempt interest. Tax-exempt interest from certain private activity bonds (other than qualifying bonds issued in 2009 or 2010) isn’t exempt for AMT purposes. Thus, although you exclude this interest from your regular taxable income, you must include it in AMTI.
- Interest deduction. For AMT purposes you can only deduct mortgage or home equity loan interest on funds you borrowed to buy, build, or substantially improve your home or a second residence (or on the refinancing of that debt). An adjustment may have to be made to your investment interest deduction in some cases for AMT purposes.
- State and local tax deduction. For AMT purposes, you get no deduction for state and local income taxes, or real estate or other property taxes, although a deduction is allowed for regular tax purposes.
- Medical expenses. If you are deducting any medical expense for regular tax purposes, some of the deduction may be lost for AMT purposes. For regular tax purposes, for taxpayers age 65 or older, medical expenses are deductible to the extent they exceed 7.5% of adjusted gross income (AGI) for taxpayers. For AMT purposes, however, medical expenses are only deductible to the extent they exceed 10% of AGI. Thus, these taxpayers would compute their reduced deduction amount and add the difference back to taxable income in determining AMTI. (For example, if your “regular” medical deduction was $8,000 and your AMT medical deduction is $6,000, you would add back $2,000 to taxable income.)
- Miscellaneous itemized deductions. If you are entitled to a regular tax deduction for any miscellaneous itemized expenses (these are deductions that are limited, even for regular tax purposes, to the excess over 2% of your AGI), you would not get any deduction for them for AMT purposes, regardless of what they are comprised of.
- Personal and dependency exemptions. You must add them back to your regular taxable income in determining AMTI.
- Standard deduction. If you take the standard deduction instead of itemizing, you must add back the deduction to determine AMTI.
- Incentive stock options (ISOs). The favorable tax treatment allowed for ISOs isn’t allowed for AMT purposes. This means that although you don’t pay any regular tax when you exercise an ISO, you may have to pay AMT on the value of the stock you receive (minus what you paid for it) in the year you exercise the ISO unless you sell the stock that year.
- Depreciation deductions. For certain depreciable property, the depreciation schedules are slower for AMT purposes than for regular tax purposes. Therefore, some adjustments may have to be made in your depreciation deductions, and in the gain or loss on the sale of this property.
Preparing IRS Form 6251
Study Form 6251 each time you prepare your tax return to see how close you are to paying the AMT. Evaluate how close your Tentative Minimum Tax (line 34) was to your regular tax (line 35). For information on Form 6251, see the Instructions. In general, the best way to handle AMT liability is careful planning involving the coordination of future regular income tax and AMT, using accurate projections of income, expenses, and deductions over multiple years with several alternative scenarios. An overall plan must then be devised to manage your AMT liability without raising regular tax liability.