What is the Alternative Minimum Tax? Well, the alternative minimum tax, commonly referred to as the AMT, has its own set of rates (26% and 28%) and requires a separate computation that could substantially boost your tax bill. Basically, it’s the difference between your regular tax bill, figured using ordinary income tax rates, and your AMT bill, figured by filling out more IRS paperwork. When there’s a difference, you must pay that amount, the AMT, in addition to your regular tax.
Unfortunately, certain tax breaks are disallowed under the AMT, including exemptions for eligible dependents as well as certain popular deductions.
The AMT was designed in 1969 to ensure that wealthy taxpayers didn’t use loopholes to escape paying their fair share of taxes. The original target was 155 filers with the then-exorbitant income of $200,000 who avoided paying any federal taxes.
Permanent AMT relief
When an AMT payment is required, affected taxpayers could end up paying thousands more in taxes.
That possibility has been a major threat since the alternative tax’s creation because it was not originally indexed for inflation. Without that annual adjustment, a yearly raise of a few percentage points meant a taxpayer was closer to or even into the income realm that the tax law deemed almost 40 years ago as prime AMT bait.
You could owe AMT if taxable income exceeds:
|Filing status||2016 tax year|
|Single or head of household||$53,900|
|Married, filling separately||$41,900|
|Married, filing jointly||$83,800|
That oversight was corrected in 2013, with the enactment of the American Taxpayer Relief Act. Now the AMT is adjusted each year to reflect inflation.
Do more to pay more
Even with the inflation adjustment, some taxpayers still must calculate the AMT. More frustrating is that the AMT’s parallel system demands that taxpayers do more work to pay more in taxes. The effort is required in filing paperwork (the dense, 2-page Form 6251, Alternative Minimum Tax — Individuals) and maintenance of separate records for regular and alternative tax purposes.
And filers who escape actual payment of the higher tax still must do additional work just to learn that they don’t owe the AMT.
To help sort through the AMT mess, some taxpayers turn to computer software packages, most of which include AMT computation, or hire professional help. Both choices should help you stay on the IRS’ good side, especially if you owe AMT, or at least put your mind at ease if you don’t.
But the options also will add to the overall cost of calculating your tax bill.
Free help in figuring your AMT
For the past couple of years, the IRS has provided some free AMT calculation assistance.
AMT Assistant is an online tool that helps taxpayers determine whether they owe the tax. You just answer a few questions about entries on your draft 1040 and the system does the rest. Based on your entries, the calculator will tell you that either you do not owe the AMT or that you must go further and complete more computations to find out if you owe the AMT.
The AMT Assistant is especially welcome to filers who still do their taxes by hand, because the automated program essentially replaces the tedious worksheet taxpayers are instructed to use to determine if they fall under the AMT.
With the online program, says the IRS, most people will spend only about 10 minutes to find out their AMT fates.
There are a few special instances where a filer will need to take a few extra online steps, such as claiming the foreign tax credit, dealing with disaster-related tax issues or preparing a return for a child. But most taxpayers will only need Form 1040, completed through line 44, (that’s the tax you owe under the regular system,) and Schedule A if itemizing.
You don’t have to enter your name, Social Security number or other identifying data. The program, which guides you through a series of Q&A pages, only wants the numerical data from your forms.
When you’re finished, it will tell you whether you now have to fill out the AMT form, but it won’t tell you the actual tax damage. You’ll still have to fill out Form 6251 to find out that amount.
AMT starting point
How do you know, without using tax software or the AMT Assistant, if you might be caught in the AMT net? There are some indicators, but it’s not always easy to tell.
The starting point for figuring any AMT is your regular taxable income. This is the stage where the AMT Assistant (or worksheet, if you still insist on doing things by hand) kicks in.
Basically, some of the deductions you claimed to figure your regular tax bill must be added back. These are known as tax-preference items. You also might find a special exemption amount is subtracted. The resulting amount is subject to the alternative tax.
Many of the tax breaks not allowed under the AMT system do affect predominantly wealthy individuals or businesses with complicated tax circumstances. These include incentive stock options, intangible drilling costs, tax-exempt interest from certain private activity bonds, and depletion and accelerated depreciation on certain leased personal or real property.
Common tax breaks disallowed
The AMT also rejects or reduces many common tax breaks used every year by individual taxpayers to lower their IRS bills.
For example, under the AMT, you cannot deduct state and local taxes. This is a major blow to many filers, because most states collect income taxes and all jurisdictions have some type of levy that generally can be counted against a federal tax bill.
If you are 65 or older, have lots of itemized medical deductions and fall into the AMT, you’ll lose some of these deductions. Through the 2016 tax year, older taxpayers can claim medical costs that exceed 7.5% of their adjusted gross income, or AGI. The AMT, however, only allows for medical expense deductions in excess of 10% of the filer’s AGI. This isn’t an issue for taxpayers younger than 65; they already must meet the 10% deduction limit on their Schedule A.
Miscellaneous itemized deductions, although limited under the regular tax system, are disallowed under the AMT. Even large families can be hit. If your personal exemption total is big, look out.
Own a home? Some cherished home-related tax breaks take an AMT hit. While mortgage interest on your main and 2nd home is still AMT-deductible, home equity loan interest is restricted. It can’t be deducted unless the money is used solely to pay for home improvements. Your home’s property taxes also are disallowed as deductions under the AMT.
In addition, some tax credits that reduce your regular tax liability do not reduce what you owe under the AMT. Once you add back these disallowed credits and run the numbers, you might be subject to a bigger IRS bill if your taxable income exceeds the annual AMT exemption amount for your filing status.
If you find you must pay the AMT, the extra money you owe, along with the added paperwork hassle, is never welcome. But dealing with it now is better than the alternative: letting the IRS discover that you should have paid it. When Uncle Sam comes asking for back taxes, he wants interest and penalties, too.