For many taxpayers, the AMT is a mystery straight out of the Twilight Zone. What is this strange tax that shows up out of nowhere? It can hit taxpayers with a significant tax cost, yet it is scarcely understood. The key to minimizing AMT is understanding what it is, how it is calculated, and how to plan for it.
What is AMT?
The Alternative Minimum Tax (AMT) is a counterpart to the regular tax system which increases the amount of tax owed by a taxpayer. The AMT is based on regular tax but is calculated independently. AMT disallows certain deductions and also taxes income items which are nontaxable for regular tax purposes. The AMT is owed only if it is greater than the amount of tax calculated with the regular tax system.
Why Does AMT Exist?
Almost 50 years ago, Congress noticed that several taxpayers with high incomes were paying absolutely nothing in taxes. Many people automatically assumed these taxpayers’ $0 tax bill was due to tax fraud, when in fact, they were using legal deductions and other tax breaks to avoid paying taxes. To prevent this and to make the tax system appear impartial, Congress developed the AMT to ensure high-income taxpayers paid at least a minimum amount of tax.
How is AMT Calculated?
To calculate AMT, Form 6251 is used. If the amount of tax calculated on this form is greater than the amount of tax calculated on the regular tax return, the taxpayer has to pay the difference as AMT in addition to the amount of regular taxes. This article discusses the AMT calculation in the context of an individual taxpayer, but trusts, estates, and corporations can also be subject to AMT and have similar rules and calculations.
- The calculation of AMT begins with a taxpayer's adjusted gross income (AGI) minus itemized deductions (if any).
- The taxpayer then adds or subtracts AMT adjustments to determine alternative minimum taxable income (AMTI). Some of the most common adjustments are as follows:
- Add back taxes taken as an itemized deduction. This includes state income tax, sales tax, real estate tax, and others.
- Add back miscellaneous itemized deductions which are subject to the 2% of AGI limitation, including unreimbursed employee business expenses, investment advisor fees, and tax return preparation fees.
- Add back private activity bond interest. Although tax-exempt for regular tax purposes, this municipal bond interest is taxable for AMT.
- Add back or subtract the difference between the amount of depreciation deduction taken for regular tax versus AMT. The gain or loss recognized on the disposition of property can also be different for AMT purposes, and could have a corresponding adjustment as well. These adjustments can be for property directly owned by a taxpayer but could also be shown on a K-1 the taxpayer reports on their income tax return.
- If you exercise an incentive stock option (ISO), you do not have taxable income for regular tax purposes. However, the excess of the value of the stock on the date of exercise over the amount paid for the stock is income for AMT purposes. This can be prevented by selling all of the stock in the year you exercise the options
- After AMTI is determined, the AMT exemption amount is subtracted. This is a special AMT deduction that is intended to prevent lower and middle income class taxpayers from being subject to AMT. This exemption is similar to a standard deduction and is now adjusted each year for inflation. For 2015, the exemption amount is $53,600 for a single taxpayer and $83,400 for married taxpayers filing jointly. The exemption is generally reduced or phased out for high income taxpayers.
- Next, multiply the amount calculated in (3) by the AMT tax rate of 26% or 28%, depending on AMTI and filing status. Note that the taxation of capital gains and qualified dividends for AMT purposes is the same as for regular tax purposes, so there may be additional calculations needed. Certain tax credits will impact the AMT. Also, the net investment income tax is a separate tax calculation on which the AMT has no impact.
The Big Problem
The AMT exemption amount referenced above was the key in making sure that certain taxpayers were not subject to AMT. The big problem is that until very recently, this exemption was not automatically adjusted each year for inflation, resulting in many more taxpayers being pulled into the AMT trap.
Planning tips for AMT
It can be hard to get around the AMT tax, but there are some things a taxpayer can do to help mitigate the effect AMT has on his tax liability:
- If a taxpayer expects to pay AMT this year, defer paying property and state income taxes to next year, if possible. By deferring payment of these items until next year (when you may not owe AMT), you may get a tax benefit.
- On the other hand, if you think you will be paying AMT next year but not for the current year, you might want to accelerate some of the same tax payments to this year. TN residents that pay Hall Income Tax on interest and dividends can also make a prepayment of tax in the current year rather than when the return is due in the next year.
- If you pay real estate tax or other expenses that may be considered miscellaneous itemized deductions, think about if they might be related to your business, rental properties, or farm. If they are, you should separately report them with those activities instead of as an itemized deduction to prevent them from being added back to income for AMT purposes.
- If you are converting a traditional IRA to a Roth IRA and you are typically in the highest tax bracket, you might consider converting in a year you are subject to AMT. Additional income would be taxed at the 28% AMT tax rather than the 39.6% normal tax rate. Be careful though, as a large amount of income could push you out of AMT and back into regular tax.
- Consider the AMT net operating loss (NOL) if you are deciding whether to carry an NOL back or forward. NOLs are added back for AMTI. You then get a deduction for your NOL as calculated for AMT purposes.
- The tax exempt municipal bonds you hold might generate private activity bond (PAB) interest. This interest is nontaxable for regular income tax purposes, but is taxable for AMT purposes.
10/29/2018: Gross income doesn’t generally include interest on state or local bonds, according to the U.S. Tax Code. But the Tax Cuts and Jobs Act (TCJA) states that tax law shouldn’t be construed to give an exemption from federal income tax for interest on any bond issued to advance-refund another bond. The IRS Chief Counsel Advice held that bonds initially issued by a local government had been converted to non-tax-advantaged bonds. So, the bonds the local government issued to advance-refund the initial bonds were tax-exempt bonds, notwithstanding the TCJA. (CCA 201843009)
Prior Year AMT Credit
If you paid AMT as a result of exercising incentive stock options that have not been sold, or other timing items such as claiming accelerated depreciation expense, you will earn a credit that will carry-forward to future years.
This credit is available only in years that you are not paying AMT. Also, you can only take the credit to the extent your regular tax exceeds your AMT tax for the year. Accordingly, AMT should be calculated each year regardless of if you owe it or not. Any unused credit may be carried forward indefinitely.
The AMT can be very mysterious, confusing, and hit you when you least expect it! Don’t let it catch you off-guard. Ask your tax advisor if AMT impacts you and if there is anything you can do to mitigate its effects. Proper planning and knowledge will ensure you don’t get ensnared in the AMT web Twilight Zone!