Understanding the Alternative Minimum Tax

In my series on what you need to know about your income tax return, I mentioned a part of your Form 1040 that needed its own post – the alternative minimum tax (AMT). You’ve likely heard of AMT but probably weren’t sure if you needed to worry about it. Today I’ll explain the concept, and how it may affect you.

 What is AMT?

As the name implies, AMT imposes a minimum tax on the amount of your taxable income above a designated exemption.  The tax was introduced to make sure people with higher incomes pay a minimum amount of tax, rather than escape income tax entirely through their ability to take advantage of deductions and credits. AMT parallels the regular income tax system, meaning you calculate both your income tax and your AMT, and you pay the higher total.

For income tax purposes, you calculate your taxable income based on your gross income minus adjustments, your standard or itemized deductions, and your personal exemptions.  The government taxes that figure at a progressive tax rate to get the total amount of tax that you owe (which you can later reduce through tax credits).

You also calculate AMT based on taxable income. However, the taxable income figure doesn’t include certain deductions that are diminished or disallowed entirely. Some of these deductions include state and local income taxes, medical expenses, and mortgage interest on home equity debt.

You may also have to include certain types of income that you wouldn’t normally count in your regular taxable income, such as exercising incentive stock options or tax-exempt interest from private activity bonds. 

The disallowance of deductions and addition of income leads to your Alternative Minimum Taxable Income (AMTI).

When trying to understand the basics of AMT, it’s more important to know how the calculation works, rather than knowing every deduction or type of income that gets added back in to your AMTI. Your preparation software will calculate AMTI for you and show you the different aspects that affect your particular situation. However, if you’re really into figuring out the nuts and bolts of the AMTI, I will provide some resources below that will take you more in depth.

Exemption Amounts – The Second Part of Your Equation

Once you’ve figured out your AMTI, you’re 80% of the way there. The next step involves calculating the amount of income subject to tax. To do that, you need to subtract the exemption amount from your AMTI.

The exemption amounts are preset and indexed for inflation. Form 2014, you can exempt the following amounts of income:

  • $52,800 for single and head of household filers,
  • $82,100 for married people filing jointly and for qualifying widows or widowers, and
  • $41,050 for married people filing separately.

In short, your AMTI minus your exemption equals the amount of income on which you have to pay AMT.

AMT Tax Rates

Despite the complexity of the AMT system, the tax rates are pretty straightforward.

For 2014, you pay a tax rate of 26% on AMTI of $182,500 or less for those filing single, married filing jointly, head of household or qualify widower. For married filing separate taxpayers, the income threshold stops at $91,250.  The tax rate grows to 28% of income over those amounts. Multiplying the tax rate by your AMTI minus your exemption gives you your tentative minimum tax.

You may have some additional tax due if you reported capital gains distributions, qualified dividends, and/or used the foreign tax credit, but your software should add those for you.

You should note that AMT is only the difference between your regular income tax and the tentative minimum tax amount calculated through AMT. For example, if you owed $30,000 in regular income tax and your tentative minimum tax amount was $33,000, AMT of $3000 will show up on line 45 of your Form 1040

Do Your Research

AMT intimidates a lot of people, including many tax professionals. But you can find some helpful resources to guide you through the process of calculating AMT. As always, I start with the form itself – Form 6251 – and its instructions.

The IRS also offers an AMT Assistant that helps you determine whether you might be subject to AMT.

If you find yourself subject to AMT and need to develop strategies for minimizing the minimum tax, I suggest seeking a tax professional that knows the complexities of the system.