In your tax planning, don’t overlook how your tax-savings strategies might be affected by the alternative minimum tax.
What is the alternative minimum tax?
Enacted back in 1969, the alternative minimum tax (AMT) was designed to make sure that high-income taxpayers pay a minimum amount of taxes, even if they have sufficient deductions and credits to reduce their federal income tax liability to zero.
The AMT is like a flat tax. You get a lower tax rate in exchange for losing most deductions.
To calculate the AMT, start with regular taxable income, which includes all your familiar deductions and exemptions. Then make certain adjustments and add back certain “preferences” to arrive at your AMT income. Preferences include personal exemptions, state and local taxes, certain interest on home-equity loans, and miscellaneous itemized deductions.
After adding back the preferences, you’re entitled to an exemption amount, though the exemption phases out at high income levels. The exemption for 2012 is $33,750 for singles and $45,000 for married couples filing a joint return. (The AMT exemption amounts that are in effect for tax years beginning in 2012 (and later years) are significantly lower than the exemption amounts that were in effect for tax years beginning in 2011. The high exemption amounts for 2011 reflect the temporary increases that IRC Sec. 201(a) provided for 2011 (and 2010). This provision also had the effect of postponing for two years (i.e., until 2012) the lower AMT exemption amounts that had been scheduled to go into effect in 2010. This so-called “AMT patch” was designed to “hold harmless” additional taxpayers who would have been subject to the AMT if the scheduled reductions had gone into effect. In recent years, Congress has provided similar “stopgap” provisions before any extensive overhaul of the AMT system as part of a more fundamental tax reform, and is likely to do so for 2012.)
Apply a tax rate of $26% to the first $175,000 of AMT taxable income and 28% to any additional amounts. Finally, you compare your AMT to your regular tax and pay whichever is greater.
Who is affected by the AMT?
Congress created the AMT to ensure that wealthier taxpayers, who often have the kinds of income and deductions that qualify for preferential tax treatment, would pay at least a minimum amount of tax. Congress also wrote exemptions into the law, so that middle-income taxpayers wouldn’t be subject to the AMT.
Unfortunately, these exemptions were not indexed for inflation. As income have continued to rise, more and more people have found that they need to calculate their tax bill twice — once under regular tax rules, and again under the AMT.
Though Congress has expressed a desire to eliminate the AMT, it is still in effect. Every year thousands of middle-income taxpayers find themselves subject to the alternative minimum tax.
Will the AMT affect you?
Do you need to concern yourself with the AMT? You do if you have a lot of dependents or if you claim substantial itemized deductions. You may also be subject to the AMT if you realized hefty capital gains during the year or exercised incentive stock options. Claiming certain tax credits might trigger the AMT as well. And if you are an owner of rental real estate or a capital intensive business, you need to be aware that the amount of depreciation allowed under the AMT is limited.
Don’t forget the AMT in your tax planning. You may be one of those middle-income taxpayers who is now subject to this tax. For details or planning assistance you should consult your tax professional.