The alternative minimum tax (AMT) is a tax assessed against some taxpayers in addition to their regular income tax.
Its purpose is to prevent high-income taxpayers from using specific deductions and tax benefits to pay very little or even no taxes. When the AMT was implemented, it was rare that it affected individual tax filers — fewer than 20,000 individuals were subject to the AMT in 1970. But today, more than 2.5 million people are affected.
Tax law changes are one reason for the increase, but it’s also due to inflation. Whereas regular tax rate brackets and various deductions have increased with inflation over the years, AMT brackets and deductions have not increased proportionately.
Calculation of the AMT is complex, but the theory is simple. If regular income tax is as much as AMT, then no additional tax is assessed. However, if your regular tax is less than your AMT, then you must pay the higher AMT.
To calculate AMT, start with your adjusted gross income less your itemized or standard deduction. From this point, several adjustments are made to calculate your alternative minimum taxable income.
Below is a list of common adjustments that will affect most filers in determining whether the AMT will be assessed.
* Exemptions. The exemptions you claim for yourself, your spouse, your children and any other dependents are not deducted when calculating AMT.
* Medical expenses. Most taxpayers who are subject to AMT itemize deductions rather than use the standard deduction. AMT rules allow for a medical expense deduction; however, the deduction is more limited than the amounts allowed when calculating regular tax. If you claim a deduction for medical expenses, a portion or all of the amount will be disallowed.
* State and local taxes. One of the most popular deductions in calculating regular tax is the deduction for state and local taxes paid. These taxes also include real estate taxes you may have paid on your personal residence or investment properties. When calculating the AMT, these deductions are disallowed. If you live in an area where state, local and real estate taxes are high, you are more likely to pay the AMT.
* Miscellaneous itemized deductions. When computing your regular income tax, certain itemized deductions are allowed if they are in excess of 2 percent of your adjusted gross income. These include unreimbursed employee business expenses, investment expenses and tax return preparation fees and are not allowed for the AMT. If your miscellaneous itemized deductions are high, so may be your chances of paying the AMT.
* Incentive stock options. In the world of increasingly creative compensation, many employers have set up incentive stock option plans. Generally, the exercise of incentive stock options will not affect your regular income tax calculation. However, AMT rules require that when stock options are exercised, you must make an adjustment between the market price and the exercise price of the stock on the date of exercise. These adjustments can be reversed once the stock is sold.
* Long-term capital gains. These receive the same treatment for the AMT as they do for regular income tax. However, if you have a large amount of capital gains in any given year, you may be subject to the AMT because the higher the capital gains, the more the AMT exemption is reduced. If the gains are large enough, the AMT exemption can be eliminated.
* Interest on a second mortgage. In computing the AMT, a deduction is allowed for interest paid on a home mortgage to the extent the funds were used to build, buy or improve your home. If you used the borrowed money for any other purpose, the deduction is not allowed for AMT purposes.
The complexity of our tax system has grown over the years. The time when certain tax laws only affected the highest income taxpayers has vanished.
If your income is over $75,000 and you incur any of the deductions above, it is imperative that you consider the AMT. With proper planning, it can be reduced or eliminated. Sam Tuck ([email protected]) is a shareholder with Tauber & Balser PC in the tax department. He has more than 15 years of experience with a strong concentration in taxation, real estate and small to mid-sized businesses. He has also developed expertise in technology-based companies, S corporations and limited liability companies. Reach him at (404) 814-4949.
