Alternative Minimum Tax: How It Works
The United States income tax system is designed to ensure that those with higher incomes pay a larger percentage of their income in the form of income tax than those with lower incomes. However, since some high-income taxpayers also have large deductions, they may have a low average tax rate. Enter the Alternative Minimum Tax, a mechanism instituted by the IRS to ensure that high-income taxpayers pay their fair share of taxes.
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The Alternative Minimum Tax, or AMT, is designed to provide a floor below which a person’s tax obligation cannot fall by taxing things that would not otherwise be subject to taxes, like company stock options. It ensures that, despite allowable deductions, high-income taxpayers still have to pay a certain amount of tax.
Who Pays the Alternative Minimum Tax?
Those taxpayers who have a high level of income and also have a high amount of deductions, resulting in an unusually low tax burden, may be subject to the AMT. Here are some examples of how taxpayers may end up in this situation.
1. Stock Options and Company Stock
Taxpayers who exercise incentive stock options and buy their company’s stock at a discounted price may be affected. The regular tax does not tax these purchases, but AMT does.
If you purchase stock at a significant discount to the current asking price — as a result of getting in on the ground floor of a successful startup, for example — you may be subject to AMT.
2. High Income and Capital Gains
You have an income greater than $1 million and a high ratio of long-term capital gains to ordinary income. Long-term capital gains are typically taxed at 15% – 20%, but if your gains make up a substantial portion of your taxable income, the AMT could be triggered.
This situation could arise if, for example, you sold a business that you had owned for a long time that increased in value significantly during that time.
3. Income From Certain Sources
You may be subject to AMT if you have income from certain sources, like private activity bonds, intangible drilling costs or accelerated depreciation on some leased personal or real property.
How the Alternative Minimum Tax Is Calculated
To calculate the Alternative Minimum Tax, you first have to calculate the tentative minimum tax. To do this:
- Calculate taxable income.
- Eliminate or reduce certain deductions and exclusions that are not allowed under the tentative minimum tax. Account for the differences in certain items that are used to calculate regular taxable income and alternative minimum taxable income, or AMTI.
- Subtract the AMT exemption amount.
- Multiply the result by the appropriate AMT rate.
- Subtract the AMT foreign tax credit.
If the tentative minimum tax is greater than the regular tax for the year, you are subject to the Alternative Minimum Tax. If you are, you may be required to complete IRA Form 6251, Alternative Minimum Tax – Individuals, and attach it to your Form 1040. If the regular tax rate is higher, you pay that.
What Is the Alternative Minimum Tax for 2022?
For tax year 2022, the Alternative Minimum Tax rate is 26% for AMTI under $206,100 and 28% over that amount, for all taxpayers except those who are married and filing separately. For those taxpayers, it is 26% for AMTI over $103,050 and 28% for AMTI above that amount.
The Alternative Minimum Tax Exemption Amount
Taxpayers who have income above the Alternative Minimum Tax Exemption amount may be subject to the AMT. The exemption amount is calculated by the IRS each year and is adjusted for inflation. For the 2022 tax year, the AMT exemption amount is $75,900 for individual filers and $118,100 for those who are married and filing jointly. For the 2023 tax year, the exemption amounts are $81,300 for individuals and $126,500 for joint filers.
Are You Subject to the Alternative Minimum Tax?
If your income is above the exemption amount, it doesn’t necessarily mean you are subject to the alternative minimum tax. It simply means that you need to do the tentative minimum tax calculation to make sure that you’re not. Typically, in order to have to pay AMT, you would have to have an unusually high amount in deductions.
Note that most tax preparation software programs will automatically do this calculation for you and will inform you if you are subject to the alternative minimum tax.
Credit for Prior Years
If you paid AMT in prior years but are not subject to it for this year, you may be eligible for a special minimum tax credit against your regular tax this year. If you are eligible, fill out Form 8801, Credit for Prior Year Minimum Tax – Individuals, Estates, and Trusts, and attach it to your Form 1040.
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- U.S. Bank. "Alternative Minimum Tax explained."
- Internal Revenue Service. 2022. "Topic No. 556 Alternative Minimum Tax."
- Tax Foundation. "2022 Tax Brackets."