What Is the Alternative Minimum Tax and Will It Cost You Big-Time?
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.
This exclusion of the majority of taxpayers is largely due to the Tax Cuts and Jobs Act, which took effect in 2018. According to estimates from the Tax Policy Center, the TCJA reduced the number of taxpayers subject to the AMT from 5.2 million to around 200,000 in 2018. However, the tax provision sunsets in after 2025, and at that time, the Tax Policy Center expects the number of AMT taxpayers to skyrocket from 200,000 to more than 7 million.
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: $72,900 for single filers, $113,400 for married couples filing jointly and $56,700 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.
|Alternative Minimum Tax Exemptions|
|AMT Exemption||Phaseout Begins|
|Single/Head of Household||$72,900||$518,400|
|Married Filing Jointly||$113,400||$1,036,800|
|Married Filing Separate||$56,700||$518,400|
Once you figure out your remaining income after your exemption, you must calculate your tax due under the AMT formula. For 2020, the first $197,900 — or $98,950 if married filing separately — is taxed at 26% and any income over that threshold is taxed at 28%.
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% 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.
According to the IRS, you must attach the Alternative Minimum Tax, Form 6251 to your tax return if any of the following apply:
- Line 7 is greater than line 10 on Form 6251.
- You claim a general business credit and either line 6 of Form 3800 or line 25 of Form 3800 is more than zero.
- You claim the qualified electric vehicle credit on Form 8834.
- You claim the personal use part of the alternative fuel vehicle refueling property credit on Form 8911.
- You claim the credit for prior year minimum tax on Form 8801.
What’s New Regarding the AMT
Besides the exemption and phaseout amounts increasing for the 2020 tax year filings and the amounts the 26% and 28% tax rates apply to, there is one other noteworthy change. The excess business loss limitation of noncorporate taxpayers for 2020 — and retroactively to 2018 and 2019 — has been repealed. If you claimed this loss on a 2018 or 2019 tax return, use Form 1040-X to file an amended return.
What’s Your Plan? 20 Smart Things to Do With Your Tax Refund
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. If you do claim the credit, however, you are required to attach the Alternative Minimum Tax, Form 6251 to your return.
More From GOBankingRates
- These Are the Best Banks of 2021 – Did Yours Make the Cut?
- 10 Simple Habits of Money-Smart Individuals
- Top 100 Banks Leading the U.S. in 2021
- Tips To Keep Your Finances in Order Without Sacrificing What You Want
Cynthia Measom contributed to the reporting for this article.
Last updated: Feb. 8, 2021