What Is the Alternative Minimum Tax?
The alternative minimum tax, also known as the AMT, is a tax imposed on individuals who make a certain income, in addition to their income tax, to ensure that they pay the minimum amount of tax. The premise behind the AMT was to make sure that taxpayers of a certain income who were taking many deductions were still paying their fair share in taxes.
The AMT calls for certain taxpayers to calculate their tax liability two times; first, under the regulations laid out for regular income taxes, and second, to comply with AMT rules and mandates. The AMT expands the amount of income that can be taxed by the federal government.
It does so by recalculating an individual's income tax after adding certain deductions to the taxpayer's adjusted gross income. The deductions are included in the taxpayer's annual income to figure out that individual's alternative minimum taxable income (AMTI). After that, the AMT exemption is subtracted to reach the individual's tax obligations to Uncle Sam.
Primarily, the alternative minimum tax impacts higher-income Americans who earn between $200,000 to $1 million in annual income. Still, U.S. taxpayers who earn as little as $75,000 can be ensnared in the AMT, based on qualification rules set by the Internal Revenue Service.
Origin of the Alternative Minimum Tax
How did a tax law created by Congress designed to protect the middle class wind up dragging more Main Street taxpayers into a higher tax burden? It's complicated, but the Alternative Minimum Tax has a long, slightly twisted history since it was first rolled out in 1969, known then as the "millionaire's tax".
In 1969, 155 wealthier Americans used so many tax breaks, deductions, and other strategies, that each wound up paying no federal income tax. Congress caught wind of the gambit, and eventually instituted a parallel shadow tax to the U.S. tax code designed to eliminate the type of tax-avoiding strategies used by wealthy Americans.
Thus, the alternative minimum tax was born, and with it, a track record of legislative futility, as more and more middle-class Americans were ensnared in the AMT due to a major accounting omission: Unlike traditional income taxes, the AMT wasn't indexed to inflation when the bill was passed by Congress.
Eventually, the omission was fixed, and the AMT was indexed to inflation, but that didn't occur until 2013, when President Barack Obama signed off on the American Taxpayer Relief Act of 2012. That was way too late for the 5.2 million middle-class Americans subjected to the alternative minimum tax—up from 200,000 in 1982.
Another key piece of tax legislation introduced later on, the Tax Cut and Jobs Act of 2017, included a provision to significantly boost AMT exemption levels, and, hopefully, reduce the number of Americans subject to the AMT to 1982 levels.
Still, the AMT has a minimal impact on the U.S. economy, representing just a tiny fraction of the total income tax collected annually.
Focus on IRS Form 6251
Taxpayers wondering if they're subject to the AMT need to complete IRS Form 6251.
If the calculated tax on IRS Form 6251 exceeds the tax obligation listed on the regular IRS tax form, the difference needs to be paid, as well as any tax owed based on the regular IRS tax form. The taxes owed can really add up, as the AMT requires taxpayers to include tax-saving items back into their income, including:
- The individual's standard deduction.
- The deduction for state and local taxes.
- Any personal exemptions.
- Home equity mortgage interest.
- Employee business expenses and other miscellaneous deductions.
- Medical expenses.
The alternative minimum tax also kicks in after adding income earned that's not included in the regular income tax, including:
- Fair-market value of certain stock options exercised but not sold.
- Tax-exempt interest from private activity bonds.
- Foreign tax credits.
- Passive income and losses.
- Net operating loss deductions.
Alternative Minimum Tax Exemption Levels
Now that the alternative minimum tax adjusts with inflation, exemptions from the AMT are higher than prior to 2013. In 2022, IRS AMT exemption levels are as follows:
- Single taxpayers: $75,900
- Married taxpayers filing jointly: $118,100
- Married filing separately: $59,050
- Head of household: $75,900
There really isn't any practical way to get around paying the AMT. An alternative, though, is for a taxpayer to take specific steps to avoid paying the AMT the following year.
A taxpayer can do so by asking their company to reimburse them for any AMT taxes paid, doesn't prepay their real estate property taxes in the current tax year, and selling any exercised incentive stock options in the same calendar year that they exercised those options. Any exercised stock options that are unsold are deemed as income by the IRS and subjected to the AMT.
How to Plan for the Alternative Minimum Tax
Here are some additional ways to reduce taxes owed on the alternative minimum tax:
- Boost retirement plan contributions. Any contributions to an employer retirement plan, including a 401(k) plan or a tax-deductible IRA, lower your gross annual income. That lessens the odds of your qualifying for the AMT.
- Leverage a flexible spending account. Paying medical expenses through a flexible spending account or a health savings account, and funding those plans with pre-tax money, can also reduce gross annual income, and make it less likely to pay an alternative minimum tax.
- Move to itemized tax deductions. Instead of calculating taxes using the standard deduction, transition to itemized tax deductions. Certain itemized deductions are allowable under the AMT.
- Cut any taxable investment income. To further reduce your annual income, and boost your chances of avoiding the AMT, lower your tax obligations by making some smart investment moves. For instance, you can harvest investment losses to offset any capital gains earned over the course of the tax year. Big capital gains often push taxpayers into AMT territory, so any way to minimize them can help you bypass the alternative minimum tax.
- Hike your charitable contributions. Boosting charitable contributions can lower the annual income, and avoid triggering the AMT.
