So dubbed by the Tax Policy Center, the Alternative Minimum Tax, a tax intended to insure that wealthy taxpayers pay their fair share of federal taxes, is showing up on more middle class tax returns. Will you be one of those taxpayers?
The Alternative Minimum Tax has evolved since the “minimum tax” was enacted in 1969. The impetus for the tax was outrage because less than 200 ultra-wealthy taxpayers took advantage of tax law to avoid paying any federal income taxes. It was initially an add-on tax designed to limit the usefulness of legal deductions that could result in a zero tax bill.
The minimum tax became the Alternative Minimum Tax (AMT) in 1982. This tax is no longer an add-on tax but a completely separate, parallel tax system. In order to determine whether one is taxed under the regular tax system or the AMT, income must be computed twice, once under the regular tax system and then again under the AMT. There are adjustments and differences in items of income and deductions between the two systems. The tax is computed on Form 6251, and the instructions for the form are 14 pages long with numerous worksheets. If the tax computed on Form 6251 exceeds the initial tax computed on Form 1040, the higher AMT is the tax due.
Income for AMT
Income for regular tax must be adjusted for “tax preference items”. Many of these will flow through to a taxpayer from a partnership or other entity. Tax preferences include items such as excess intangible drilling costs, depletion or accelerated depreciation. However, interest on certain municipal bonds usually not otherwise subject to federal taxes (reported on Form 1099-INT) is also a tax preference item. Also included in income are a part of the income not recognized on the sale of small business stock and the spread between the purchase and grant prices of an incentive stock option if the stock is not sold in the year of exercise and. Additional adjustments could also result upon the disposition of property with a different AMT and regular tax basis. These are the most common adjustments to income, but there are more. If you feel you might be subject to the AMT you should familiarize yourself with the possible adjustments and discuss the issue with your tax preparer.
What itemized deductions are allowed?
There are a number of categories of deductions that taxpayers can itemize on Schedule A. Not all of those will be applicable for the AMT.
- Medical expenses are deductible for AMT when they exceed 10% of adjusted gross income for regular tax purposes.
- Taxes are not deductible in computing the AMT. However, a tax refund taxable for regular tax purposes when the taxpayer received no benefit from the deduction because of AMT is not taxable income for the AMT calculation.
- Mortgage interest is deductible but interest on home equity loans is NOT deductible if not used to acquire, construct or substantially improve a principal residence or qualified dwelling. The interest on a home equity loan to purchase an automobile is therefore not deductible for AMT.
- Investment interest is deductible for AMT but only to the extent of investment income after AMT adjustments.
- Charitable contributions are a deduction when determining AMTI (alternative minimum taxable income).
- Miscellaneous itemized deductions subject to the 2% floor are disallowed in their entirety for AMT. Those include, but are not limited to, employee business expenses, tax preparation fees and the fees paid to investment managers.
- The standard deduction is also not allowed for computing AMT.
How about the exemptions for dependents?
No personal exemptions are deducted when computing AMT.
Well, is there anything else to deduct before the tax is computed?
All the “above the line” deductions are allowed for AMT. Those include retirement contributions by the self-employed, the IRA deduction, ½ of self employment tax, etc. There is also an AMT exemption (see table below) that is deducted before the tax is computed. Notice that the exemption phases out above certain income levels and long term capital gains and qualified dividend income are included in determining the phase out of the exemption.
|2015 Filing Status||AMT Exemption Amount||AMT Phase-out Income Level||AMTI for 28% Tax Rate|
|Joint Returns or Surviving Spouses||$83,400||$158,900||$185,400|
|Married Individuals Filing Separate Returns||$41,700||$79,450||$92,700|
What is the AMT tax rate?
Alternative minimum taxable income is taxed at 26% up to excess AMTI (see above), 28% thereafter. Please note that capital gains and qualified dividends keep their favorable tax treatment under the AMT.
Are Net Operating Losses lost?
No, but they are recalculated based on AMT preferences and adjustments.
Are there any credits?
The only credit allowed is the foreign tax credit. However, taxpayers subject to AMT may receive an AMT credit in a subsequent year when the taxpayer is not subject to AMT.
The AMT is a complicated tax system and this article is merely an overview of the most common issues. The AMT is a system of effectively raising taxes without increasing normal tax rates. According to the Tax Policy Center: “Because of real income growth, the percentage of tax units paying AMT will rise over time from 4.2 percent in 2013 to about 5.5 percent by 2023. Over that period, the number of AMT payers will rise from 3.9 million to about 6 million. Unless Congress changes the tax, real income growth will cause more and more taxpayers to become subject to the AMT over time.”