The alternative minimum tax is a parallel form of taxation similar to the regular federal income tax system. Much like the normal federal income tax, the alternative minimum tax, or “AMT” has its own system of form and rules on income and deductions. It applies to only a small subset of income tax filers and is often difficult to discern without the assistance of a qualified tax preparer. The Tax Cuts and Jobs Act significantly increased the amount of income exempted from the AMT in 2018, which means that it applies to a smaller range of taxpayers than it did previously.
Purpose of the AMT
The alternative minimum tax was created in order to ensure that certain wealthy individuals with nontraditional tax returns (often with income that was not derived from wages) were paying at least a minimum level of income tax. The difficulty of the AMT, however, is that is not indexed to match inflation and thus, over time, the AMT has increasingly applied to middle-income individuals in addition to high net worth households.
Details of the AMT
Unlike regular income tax brackets, which start at 10 percent and gradually increase toward higher percentages, individuals subject to the AMT are taxed at either a 26% level or a 28% level. More importantly, the AMT is distinguished by the fact that certain typical tax breaks are excluded from consideration. For instance, individuals subject to the AMT do not get a standard exemption for taxes, nor do they receive deductions for dependents, state or local taxes that they have paid, or other itemized deductions.
Essentially the AMT works as such: An individual determines his or her general taxable income, as recorded in normal federal tax returns. However, for purposes of the AMT, the individual adds back in income from sources that would normally be excluded, and adds back in personal and dependent exemptions. Also added are deductions that are not allowed under the AMT, such as deductions for interest on home equity loans. Once a total income is reached, the individual then subtracts the AMT exemption that applies, which is approximately $111,700 for joint tax filers and $71,700 for single filers as of 2019. Once the overall income that is left is determined, the AMT rate of 26 percent is applied to the first $175,000 in income, and then the 28% rate is applied to anything beyond that. Finally, the taxpayer must compare what is due under the AMT to what is due under normal federal income taxes. He or she must then pay the higher amount of the two.
If this sounds complicated, it is because it is. Individuals rarely understand why they are subject to the AMT or how it applies. If you have concerns about the applicability of the AMT to your tax return, it is best to consult a tax professional.
Who Must Pay the AMT
The most difficult aspect of the AMT is that there is often no easy way to determine whether the AMT is applicable to your tax planning before going through the process of calculating AMT and regular federal income taxes. Tax preparation software can frequently determine whether the AMT may apply to your returns, as can a tax professional. However, just because you are subject to the AMT one year, does not mean that you will be subject to it the next. Rather, it must be calculated on an independent basis each year. The best bet, for all individuals, is to consult a qualified tax lawyer or tax accountant.