What Is the Alternative Minimum Tax (AMT)?
If you’ve never heard of the Alternative Minimum Tax, or AMT, that’s probably because you’ve never had to pay it. Lucky you! Nobody’s thrilled about having to pay taxes, but the AMT has a particularly beastly reputation.
What Is the Alternative Minimum Tax (AMT)?
The original intent of the AMT was to keep high earners from using loopholes to avoid paying their fair share of taxes by taking too many deductions or write-offs. (That seems fair, right?) Essentially, the Alternative Minimum Tax is a parallel tax system where taxpayers must calculate their income taxes two different ways—under the regular tax system and under AMT rules—then pay whichever tax is higher.
High-income taxpayers with large tax write-offs—dependents, high property taxes and high state income taxes, for instance—may find themselves paying the tax, which works by taking away deductions for an overall higher tax bill.
Unfortunately, over the years, what was once considered “high income” is now decidedly upper middle class, but the AMT hasn’t been adjusted appropriately. (It has not historically been indexed to inflation the way the rest of the tax code is.) So earners you wouldn’t necessarily tag as “super wealthy” get hit with the tax bill.
Congress has been “patching” the AMT by passing temporary legislation to bump up the income threshold before you’re stung by it (and finally made the patch permanent in 2013), but it still affects more upper-middle-class taxpayers than intended.
RELATED: Why You Could Get Hit With the AMT
Why You Don’t Want the AMT
If you’re paying the AMT, you’re paying more taxes than you would otherwise have to pay, because it doesn’t allow you to take deductions many taxpayers can take advantage of. And if you live in an area where you’re already paying high state income taxes and high property taxes, for instance, it can feel like adding tax insult to injury when you can’t deduct them on April 15.
AMT is considered a flat tax with two tax rates: In 2014, for all taxpayers except those married filing separately, the rate is 26% on taxable income under $182,500 and 28% on taxable income over that. For married filing separately, it’s 26% for taxable income under $91,250 and 28% on taxable income over that.
However, the “taxable income” in this scenario is the number that was recalculated under AMT rules—without all the allowed deductions and credits. So even if the minimum tax rate is lower than your marginal income tax bracket, your taxable income is higher—so you’ll pay more. Bottom line: If you’re paying the AMT, you are paying higher taxes. Period.
Who Pays Alternative Minimum Tax?
In general, you may be subject to the AMT if your income falls between $150,000 and $750,000, says Alan Rothstein, founder and CPA at Rothstein & Co., CPAs in Avon, Conn. But your chances increase if you:
- Have a high gross income relative to your taxable income
- Have a large number of dependents
- Exercise and hold incentive stock options. (For instance, if you work for a tech company.)
- Realize significant long-term capital gains
- Have large deductions on your Schedule A, such as medical expenses or state and local taxes (including property taxes)
Not sure if it will apply to you? If you’re working with a tax preparer, he will tell you if you owe the AMT. If you’re using tax software, most programs now will calculate the AMT and let you know if you must pay it.
If you want to find out before tax time, you can use this tool from the IRS. There aren’t many things you can do at tax time to ease the bite, but if your accountant knows in advance, he might be able to help you strategize ways to minimize your exposure. “We can address and make changes before the end of the year,” Rothstein says.
Depending on your income, there is an AMT exemption that factors into the tax calculation—and that is now indexed to inflation, so it will increase annually. The exemption is the amount a taxpayer can subtract from taxable income before calculating the AMT. In 2014, the AMT exemption for married couples filing jointly is $82,100 and $52,800 for singles.
The AMT exemption phases out when your income exceeds a certain level. In 2014, the phase-out threshold for married couples filing jointly is $156,600 and $117,300 for single taxpayers. Your AMT exemption is reduced by 25% of the amount by which your taxable income exceeds these numbers.
To make things slightly more confusing, there is also the possibility of an AMT credit. That is, if you paid the AMT this year for certain items, such as exercising a specific type of stock option, you could earn credit that you can claim in a future year. But there are a variety of rules about when and how you can claim the credit, so make sure you consult an accountant.
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