The alternative minimum tax was first introduced in 1969 as a way to prevent wealthy people from taking advantage of so many income tax deductions and credits that they paid little, if any, income taxes. The good news is that most taxpayers won’t even have to worry about calculating whether they owe any AMT because their total income is below the AMT exemption amount.
Taxpayers who are subject to the AMT, however, could end up with no tax refund — or owing extra with their tax filing. Find out how the AMT is calculated and what factors make you more likely to be hit with this extra tax bill.
How the AMT Is Calculated
Your AMT due is equal to the difference between what you owe under the AMT formula and what you owe under the standard tax calculations. The IRS uses Form 6251 as the alternative minimum tax calculator.
To calculate your AMT, you must first recalculate your income after eliminating several exclusions and deductions. For example, under the AMT, you can’t deduct state and local income or sales taxes, interest on home equity debt, or miscellaneous deductions like employee expenses or tax preparation fees, and you have to add back income from private activity bonds that are normally excluded. In addition, your total itemized deductions are limited based on your filing status.
After recalculating your total income, you reduce it by your AMT exemption, which depends on your filing status: $54,300 for single filers, $84,500 for married couples filing jointly, and $42,250 for married individuals filing separately. When your income exceeds the phaseout amount for your filing status, however, your exemption is reduced by 25 cents for every dollar you are over the limit.
After tax year 2017, however, the AMT exemption amount will increase because of the changes in the federal tax law. Starting in 2018, the exemption is increased to $70,300 for single filers and doesn’t start to phase out until $500,000 and is increased to $109,400 for joint filers and doesn’t start to phase out until $1,000,000. The increased exemptions are scheduled to sunset after the 2025 tax year.
|Alternative Minimum Tax Exemptions|
|AMT Exemption||Phaseout Begins||AMT Exemption||Phaseout Begins|
|Single/Head of Household||$54,300||$120,700||$70,300||$500,000|
|Married Filing Jointly||$84,500||$160,900||$109,400||$1,000,000|
|Married Filing Separate||$42,250||$80,450||$54,700||$500,000|
Once you figure out your remaining income after your exemption, you must calculate your tax due under the AMT formula. In 2017, the first $187,800 — or $93,900 if married filing separately — is taxed at 26 percent and any income over that threshold is taxed at 28 percent.
Finally, you must subtract the foreign tax credit. If your AMT tax is greater than what you would owe under the standard tax formula, you pay the higher AMT amount.
Who Pays Alternative Minimum Tax
The differences between how your regular taxes are calculated and how the AMT is calculated affect the types of people who are more likely to be hit by the AMT. Though it might seem counterintuitive, the AMT usually doesn’t hit the highest income earners because their marginal tax rate is already much higher than the 26 or 28 percent levied by the AMT.
First, the AMT disallows personal exemptions, so parents with several children are more likely to owe under the AMT. Second, the tax hits married filers harder than single filers because the tax brackets are the same and the married exemption is less than double the single exemption. Third, the AMT affects people who live in high-tax states because the state and local tax deductions are disallowed.
Strategies to Minimize Your AMT Liability
There’s only so much you can do to avoid the AMT. The most effective strategy is controlling when you receive and recognize income and deductions.
For example, when planning a large Roth conversion or considering selling an asset that will trigger a large capital gain, consider whether that transaction will subject you to the AMT.
Alternatively, taxpayers who are subject to the AMT one year but don’t expect to be subject to it the next year should try to delay eligible deductible expenses, such as local property taxes and state income taxes to be able to claim the deductions instead of losing them.
When you’ve paid the AMT in prior years, however, but you don’t owe the AMT this year, you could qualify for a special tax credit for paying the tax in the past. To claim the credit, file Form 8801 with your income tax return.