AMT: What is it exactly?

The Alternative Minimum Tax originally took effect in 1970 as a separate tax system built around the notion that high-income individuals should pay a minimum amount of tax, even if they qualify for tax benefits that would otherwise allow them to pay less.[1]  For most of you, the 2009 tax season has come and gone and you may have already had to deal with the AMT nightmare. But for those who have yet to pay 2009 taxes, the Alternative Minimum Tax may still be waiting for you.    For most of you, the 2009 tax season has come and gone and you may have already had to deal with the AMT nightmare. But for those who have yet to pay 2009 taxes, the Alternative Minimum Tax may still be waiting for you.

In order to ensure that certain taxpayers who benefit from regular tax deductions and credits pay at least a minimum amount of tax, the AMT is computed separately from the regular tax calculation and disallows many deductions and credits available under the regular tax regime.  Deductions and credits that are disallowed for AMT are referred to as ‘AMT tax preference items.’ These items are added back in to adjusted gross income, and the result ultimately may be subject to tax liability. Common AMT tax preference items include:

• state and local income taxes
• sales and property taxes
• accelerated depreciation
• a portion of otherwise deductible medical expenses
• miscellaneous itemized deductions
• the bargain element in exercised incentive stock options
• percentage depletion
• certain tax-exempt income
• certain credits
• personal exemptions and
• the standard deduction.[2]

Once these tax preference items are added back in, the Alternative Minimum Taxable Income (AMTI) is determined, and then taxed at the AMT rates to get the Tentative Minimum Tax (TMT), or the amount you are required to pay as part of the AMT laws. If the TMT is higher than the regular tax liability for the year in question, taxpayer pays the higher amount.

In recent years, the AMT rules have been the subject of controversy.  Regular income tax is indexed for inflation, but the AMT is not—an important distinction.  That means the annual inflation adjustments that reduce regular income tax are not calculated under the AMT rules.  This glitch in the system potentially increases both the number of people paying AMT and the amount of AMT those individuals pay.[3]  The AMT rate is 26 percent, with a 28 percent rate imposed when Alternative Minimum Taxable Income (AMTI) exceeds $175,000.  The same capital gains and dividends tax rates that apply for regular tax also apply in computing AMT.    The AMT rate is 26 percent, with a 28 percent rate imposed when Alternative Minimum Taxable Income (AMTI) exceeds $175,000.  The same capital gains and dividends tax rates that apply for regular tax also apply in computing AMT.

The thresholds for the 28 percent AMT rate and the phase-out of the AMT exemption amount have never been indexed for inflation.  Since 1993 the exemption amounts have been set permanently at $45,000 (for a joint return) or $33,750 for a single taxpayer.  However, in a series of temporary legislative ‘patches,’ the statutory AMT exemption amount has been raised on a year-by-year basis, with the 2009 exemption amount at $70,950 on a joint return and $45,700 for a single taxpayer. But an important fact to keep in mind is that a ‘patch’ has not yet been enacted for 2010. Without one, the exemption amounts would revert to their permanent levels.[4]  This means that many medium-income taxpayers may find themselves subject to the AMT.  This means that many medium-income taxpayers may find themselves subject to the AMT.

Many of you may be wondering if you can avoid the AMT. The first step in understanding the answer to that question is recognizing that the AMT is not a simple add-on tax, but rather a separate and distinct tax calculated independently of other taxes on your return.  Some strategies that reduce or eliminate the AMT attempt to do so by increasing the regular tax, and thus do not reduce the taxpayer’s overall tax liability.[5] 

A more relevant question is finding a way to minimize your Tentative Minimum Tax (TMT). The simple method is to have fewer AMT tax preferences like the ones mentioned above.  Doing so may reduce the TMT, thereby reducing the overall amount owed. For most taxpayers, the largest AMT preference items are state income taxes and local real estate taxes.  In any given year, if a taxpayer’s TMT is substantially greater than his or her regular tax, the taxpayer may be able to reduce their TMT by pushing the last real estate tax payment or state estimated taxes into the next year.  Conversely, if the TMT is much lower than regular tax, prepayment of state and local taxes may help avoid AMT liability in the following year.[6] Your tax professional can assist you with these calculations so you can make the correct decision. Your tax professional can assist you with these calculations so you can make the correct decision.

The standard deduction, used by some taxpayers who choose not to not itemize their deductions when filing their return, is an AMT tax preference item.  As such, it is reduced to zero when computing TMT.  If an AMT liability results when the standard deduction is claimed, it may decrease or disappear when itemizing deductions, even in circumstances where the itemized deductions are less than the standard deduction.  Even if the AMT liability decreases, the total tax liability may increase or decrease when changing from the standard deduction to itemized deductions. There is no simple rule to follow when the AMT is involved.  Your tax preparer should compute your return both ways—using the standard deduction and itemized deductions—to ensure the greatest benefit in a given year.[7] 

There is a small silver lining. If you do find yourself liable for the AMT, a portion of the tax you are required to pay may be available in later years as a Minimum Tax Credit to reduce the tax you owe in the future, but not below the taxpayer’s TMT level in those later years.[8]  To claim the Minimum Tax Credit you must simply file Form 8801 with your Federal tax return.    To claim the Minimum Tax Credit you must simply file Form 8801 with your Federal tax return.

As you can tell, the Alternative Minimum Tax is a complex section of the Internal Revenue Code.  If you are concerned you will be subject to AMT in the future, consult with your tax advisor to determine the options available to you to minimize your TMT, thus reducing your AMT tax liability.

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