Alternative Minimum Tax (AMT)

Well, it’s almost April 18th (the tax deadline is extended three days this year). If you’re like most people waiting until the last minute to file, you likely anticipate owing taxes instead of receiving a refund. And, if you owe tax, you may have higher than average income, which means at some point, you could be subject to Alternative Minimum Tax (AMT). What is AMT, you say?

In short, the AMT is a tax provision that ensures your tax bill will be higher than it would have been without AMT. AMT itself is based on a complex series of formulations and depends on your income, deductions, and other factors. It is not an “add-on” tax, but is rather a parallel tax calculation where the filer is required to pay the higher of the two tax amounts calculated under the normal system or the AMT system. The predecessor to AMT called “minimum tax” was first introduced in 1969 in part because 155 affluent tax filers paid no federal taxes. What impacted a mere 155 persons in 1969 now affects millions because until recently, AMT was not effectively adjusted for inflation. AMTs impact today, as the “greater of” the two tax calculations, was introduced in 1982, with some modifications made since then. In the current form, AMT mainly functions to limit the use of deductions. According to the IRS, “Under the tax law, certain tax benefits can significantly reduce a taxpayer’s regular tax amount. The AMT applies to taxpayers with high economic income by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax.”

While individuals, corporations, estates, and trusts may all be subject to AMT, it is filers who claim more significant deductions such as dependents, mortgage interest and charitable deductions or who have capital gains, or higher state or local income taxes who are more likely to be susceptible to the AMT calculation. These tax advantages are not applied to the AMT calculation, like they are to normal federal income tax calculations. Also, the higher your income, the more likely AMT will affect you.
How much income is necessary before you could be affected by AMT? Not as much as you may think. While every tax situation is different, we usually begin to see AMT negatively impact a married couple’s tax burden at around $200,000. According to the IRS, “The Alternative Minimum Tax [individual] exemption amount for tax year 2016 is $53,900 and begins to phase out at $119,700 ($83,800, for married couples filing jointly for whom the exemption begins to phase out at $159,700) . . . “. This impact can become greater as your income increases, but there is actually an AMT “Sweet Spot” where AMTs effect is reduced.

So, how can you reduce the impact of AMT? One way is actually to further increase your income into this “Sweet Spot”. While AMT reduces your ability to take deductions, the top tax bracket for AMT is 28% instead of 35%. This means that the AMT tax amount grows more slowly than the regular tax amount. This Sweet Spot is different for everyone each tax year, but for most it will be at annual incomes between ~$500,000 and $750,000.