Summary: The alternative minimum tax is a parallel tax system designed to make sure everyone pays their fair share. Click through for an overview of this controversial and misunderstood provision and to see if it might affect you.
The alternative minimum tax was created to ensure that all taxpayers pay their fair share of taxes, even when claiming any and all relevant credits and deductions. The AMT increases the amount of income that can be taxed by not allowing people to claim many of the deductions that are applicable under the regular tax system.
AMT rates can either be 26% or 28%, but the exact rate that you’ll have to pay will fully depend on the value of your AMT taxable income. If an income is greater than the predetermined AMT exemption amounts, then the AMT will likely be triggered. From there, AMT payers will essentially have to calculate their income tax twice, once in accordance with the regular tax rules and once in compliance with the stricter AMT rules. Then, they’ll have to pay the higher of the two values.
If you are interested in figuring out whether you will owe more tax as a direct result of the AMT system, then it is wise to fill out Form 6251, which contains information regarding which tax breaks are affected by AMT calculations. Taxpayers typically look for deductions, credit options, and other ways to minimize their taxable income.
Under the AMT, you cannot take advantage of as many tax breaks as people can outside of the AMT. For instance, deductions pertaining to both state and local taxes, including property taxes, are often targets of the AMT. You likely will not receive the standard deduction or any personal exemptions in this case, and a wide array of business expenses are often curtailed.
Investors might also have to deal with the AMT because long-term capital gains, as well as certain dividends, have the propensity to elevate your income to a place where it is impacted by the AMT system. When it comes to medical expenses, they have to surpass 7.5% of your gross annual income in order to be deducted. Also, home equity loan interest is typically restricted, meaning it can only be deducted if and when the money is strictly being used to pay for home-related matters or improvements.
Under the AMT, various other tax breaks are not allowed if they only impact people who are regarded as bringing in high annual incomes. These are some of those tax breaks:
- Corporate benefit of incentive stock options
- Costs related to drilling
- Interest accrued via private bonds that is also exempt from taxes
- Depletion or accelerated depreciation resulting from property
Congress successfully implemented the AMT in a way that makes it nearly impossible to avoid this tax, but by maxing out your 401(k), inherited Roth account, or health savings account, you can reduce your annual adjusted gross income, which can help. Another option is to intentionally manage your long-term capital gains in a manner that reduces the impact of the AMT.
Understand the differences between AMT and regular taxes
If you are interested in avoiding the AMT, you need to understand how the AMT is different from the regular tax system. The process of figuring out what your financial liability is in the eyes of the AMT can be very complex and confusing.
For starters, the AMT exemption accounts for taxes that are due in April 2022. For single taxpayers, the AMT value is $73,600. On the other hand, the value of the AMT for married taxpayers who plan to file together, or jointly, is $114,600. If you are under the age of 24 and the value of your AMT exemption is equivalent to your earned income, then you’ll add an additional $7,950 to the AMT exemption value.
In the beginning, the AMT was not indexed for inflation, causing something known as bracket creep. Essentially, bracket creep refers to situations in which the AMT started impacting people who were considered upper-middle class, as opposed to the upper class alone, as it was supposed to do. In order to combat this error, as of 2015, the U.S. government has started indexing the AMT in response to inflation.
When searching for tax software that will calculate both the AMT and regular tax values, we recommend referencing Form 1040 and Form 6251. Since the process can be quite complicated, your best bet will always be to consult an experienced and qualified tax professional.