Alternative Minimum Tax - Your Guide to AMT
Every year around tax time, you have probably heard about the Alternative Minimum Tax or AMT. It is a term that is familiar to many Americans, but since most taxpayers will not have to pay it, the exact meaning of the AMT often gets lost. What follows is a simple guide to the meaning of the AMT, what triggers it, what recent changes have been made to it, and how you can ensure never having to pay the AMT.What is AMT?
Created by Congress in 1969, the Alternative Minimum Tax was colloquially called the “Millionaire’s Tax” because it was designed to tax wealthy individuals who otherwise might avoid paying taxes all together. This was due to a study conducted by the IRS in 1969 which revealed that 155 millionaires used deductions not available to most people and avoided paying taxes.
In the 1980s, the AMT was changed considerably and is still mostly in effect today. It added more exemptions, including medical costs. However, it also removed many of the deductions only available to the very rich. By 2013, the American Taxpayer Relief Act indexed the income thresholds to the changes made by inflation to prevent the middle class from qualifying for the AMT. You should always consult a tax professional, EA, CPA, lawyer to legally minimize your tax burden.
It is considered a mandatory alternative to the standard income tax system that is currently in use. It is designed for those in higher tax brackets who make more than the listed exemption. Plus, it usually strikes those who use many of the deductions found in the standard tax form. Because the AMT eliminates most of the deductions, those in higher tax brackets often find themselves having to pay more because of it. Some of the deductions not included in the AMT are as follows:
- Standard, personal, and itemized deductions
- State and local income taxes
- Foreign tax credits
- Employee business expenses
- Medical expenses
- Real estate and personal property taxes
The AMT also does not allow interest on your home equity mortgage with one exception. If you used the mortgage to make recognized improvements to your home. There are certain income streams that might not be included on the standard income tax that would qualify.What are the Tax Rates for the AMT?
The one aspect of the AMT that might be considered superior to the standard tax form is that there are only two tax rates that apply. Income that is below the AMT threshold but qualifies through other means is 26%. If the threshold is surpassed, the tax rate is 28%.
The threshold rate in 2017 for the AMT was $187,800 for single and married filing together or $93,800 for those who file separately if they are married. That number goes up in 2018 to $191,500 for single and married filing together and $95,750 for married couples filing separately.What Triggers AMT?
To trigger the AMT, you will need to meet at least one of the following conditions;
- Household income above threshold of phase out, generally $150,000 to $1 million
- A large earning form capital gain, such as selling a house for example
- Exercising stock options without selling them in the same year still counts as profit
IRS Form 6251 will let you know if you are vulnerable to paying the AMT. You may need to hire a tax professional, EA, CPA, lawyer just to be sure. The AMT tends to come and go from year to year, so you should plan ahead and see when you are most vulnerable.What is the Phaseout for AMT?
The phaseout refers to the income levels where the exemption for the AMT starts to be reduced. So, if your AMT reaches a certain threshold, you will lose about one-quarter or 25 cents for every dollar that your AMT exceeds that set threshold. The threshold is different for single, married filing jointly, and married filing separately, so you will need to check depending on your income status.
Remember, head of household and single are calculated the same, so keep that in mind when looking at your AMT.Changes to the AMT
The Tax Cuts and Jobs Act, which was passed under President Trump on December 22nd, 2017, makes considerable changes to the structure of the AMT. While the Alternative Minimum Tax does stay in place, the exemption levels, along with the phaseout levels are raised starting in 2018 and running to 2025. The bill did eliminate the AMT for corporations and greatly reduces the number of individuals who will have to pay it.
In 2016, 5 million individuals paid the AMT instead of the standard tax. In 2017, only 200,000 will have to pay the AMT. The remarkable reduction means that only a select few will have to pay the AMT and those who are still subject to this tax may pay less. Consult an expert tax professional, EA, CPA, lawyer for TCJA impact.How to Avoid the AMT?
The most direct way to avoid paying the AMT is to not have your income exceed the level in which the Alternative Minimum Tax will kick in. This means avoiding the income starting at $150,000 if possible. However, for those who will have to pay there are ways to avoid or minimize the effect the following year.
- State Withholding: Make sure it is not higher than your expected payment. Remember, state tax payments are not deductible under the AMT.
- Do Not Prepay Property Taxes: Only pay your property taxes when they are due
- Sell Stock Options Quickly: You should sell them the same year you exercise them. Otherwise, the value of the options themselves counts as income in terms of the AMT.
- Reimbursement: For employees, ask your company for reimbursement in paying the higher tax.
While the Alternative Minimum Tax will only affect a small fraction of taxpayers thanks to the new law, it is still present and must be followed if your adjusted gross income exceeds the exemption amount. By recognizing when the AMT kicks in and taking the appropriate steps, you can minimize your risk of having to pay the higher taxes.
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