What Is AMT & Why Do I Have To Pay It?

By Emily Irving & Melanie Hou, CPA

Alternative Minimum Tax (AMT) is exactly as it sounds. It is an alternate method of calculating income tax. On your tax return, if the AMT method results in higher tax than the regular method, the difference between the two is the additional tax that you’ll be required to pay.

From wealthy to middle class…

AMT has undergone several changes since it was enacted in 1969. It was conceived after taxpayers were outraged over 155 high-income households that were able to reduce their tax liabilities to zero after taking deductions and benefiting from tax loopholes. As time went on, AMT, which was designed to tax the wealthiest taxpayers, started to impact middle class taxpayers.

After experiencing negative results from not indexing the AMT exemption to inflation, Congress traditionally passed one-year patches, which would increase the AMT exemption amount and income thresholds.

A few years ago, the American Taxpayer Relief Act of 2012 raised the exemption and income threshold amounts, permanently indexed AMT to inflation, and allowed tax credits under AMT. The exemption amount is intended to prevent AMT from applying to taxpayers in lower tax brackets or with a small amount of deductions. As a result, the number of AMT taxpayers fell from 4.6 million in 2012 to about 4.1 million in 2015. That number will grow to 4.8 million by 2025 estimated by Urban-Brookings Tax Policy Center (a non-partisan research group).

Did you know…The Urban-Brookings Tax Policy Center projected that for 2015, the AMT is expected to generate $28.2 billion (about 2.0 percent) of individual income tax revenue. The alternative minimum tax revenue has grown significantly over the years, starting with the add-on tax in 1970 which totaled $122 million (0.14 percent) of individual income tax.

Why did I get hit with AMT?

Individuals, C corporations, estates, and trusts are subject to AMT. The additional tax is not paid separately, but is included in the total tax liability on the tax return. If an individual has to pay AMT, the tax will be calculated on IRS Form 6251 and will be reflected on IRS Form 1040, line 45.

The complex computation of AMT on Form 6251 essentially disallows certain deductions and tax benefits and adds them back when calculating your tax liability. As mentioned above, the calculation does take into consideration the AMT exemption amounts, which is the amount you’re allowed to deduct from your taxable income before calculating AMT. For 2015, the AMT exemption amounts were $53,600 for single or head of household taxpayers, $83,400 for married taxpayers filing jointly and surviving spouses, and $41,700 for married persons filing separately.

Now you see me; now you don’t….

There are several factors that increase your chances of owing AMT. Let’s discuss a few deductions that may be disallowed:

State and local taxes: If you itemize your deductions, there is a good chance you claim a deduction on Form 1040 Schedule A for the state and local income tax that you paid during the year, as well as real estate and personal property taxes. While the taxes paid are included in your total itemized deductions, they may be partially or completely disallowed when AMT is calculated.

Personal exemptions & standard deduction: The exemptions you claim for yourself, your spouse, and your dependents are not allowed when calculating AMT. Also, if you claim the standard deduction, the full amount of the deduction is added back when determining alternative minimum taxable income.

Tax exempt interest: Municipal bond interest and dividend income that is tax-free under the regular tax rules may be taxable under the AMT rules. The year-end broker statements should report the amount of tax-exempt income that is subject to AMT.

Home equity interest: AMT only allows a deduction for interest paid on mortgages used to buy, build or improve your home. If an equity loan was borrowed against your home for another purpose, the interest deduction is not allowed under alternative minimum tax rules.

Miscellaneous itemized deductions: If the combined amount of miscellaneous itemized deductions (i.e. tax prep fees, investment fees, non-reimbursed employee expenses, etc.) exceed 2% of your adjusted gross income (AGI) and are deducted on Schedule A, the deduction will be added back to calculate your AMT liability.

Incentive stock options: You generally don’t owe regular income tax until you sell incentive stock options (ISOs). For AMT purposes, however, when you exercise the options, the difference between the stocks fair market value when purchased and the exercise price is included in your AMT income. However, the AMT generated by the exercise of ISOs can generate a credit against regular income tax in future years. Please do not lose track of your credit.

Credit for prior year minimum tax.

Some taxpayers who have paid AMT in previous years are allowed a credit against regular tax in future years for the amount of AMT, which is calculated on IRS Form 8801, Credit for Prior Year Minimum Tax. The credit is generally limited to the amount of AMT generated by deferral items, such as exercise of incentive stock options, rather than exclusion items, such as state and local taxes.

Are you planning ahead?

Congress was successful in making AMT difficult to avoid. However, there are strategies to minimize the consequences of AMT. For example, one option may be to consider paying your state 4th quarter estimated income tax in January of the following year, since you won’t benefit from the state income tax deduction if you’re subject to the AMT.

We can assist with tax projections to help you plan ahead and discuss with you options that are appropriate for your particular tax situation.