While their $0 tax liability was legal within the tax code at the time — they were using federally allowed income deductions and tax breaks appropriately — the government was embarrassed and moved quickly to legislate a solution. From this, the AMT, or Alternative Minimum Tax, was created, with the aim of making the tax system fairer.
What is the alternative minimum tax?
The alternative minimum tax mandates that many taxpayers must calculate their taxes owed by using an “alternative method” as well as the traditional method — and pay the higher of the two tax amounts calculated.
While the tax cuts of the Reagan era eliminated most of the original deductions that led to its creation, the AMT has remained intact to this day. The AMT got a massive revamp in 2017 thanks to the Tax Cuts and Jobs Act. Before, those who were well off were impacted the the AMT, but not necessarily those in the highest income brackets.
Today, the AMT just impacts the highest earners – or about 0.1% of total U.S. households. The rates are simple- either 26% or 28% depending on your income and filing status.
How does the AMT work?
The AMT is an alternative set of rules for calculating your federal income tax. The rules determine the minimum amount of tax your income requires you to pay. If you’re already paying at least that much because of the regular income tax, you don’t have to pay AMT. But if your regular tax falls below the minimum, you have to pay the higher AMT amount.
The AMT takes away certain breaks allowed by the regular income tax system. Under AMT, these tax deductions are eliminated:
- Your regular personal exemption;
- Dependent exemptions;
- Deductions for state and local taxes paid;
- Deductions for home equity loans unless used to improve your primary residence; and
- Foreign tax credits.
Basically, many of the deductions that you can claim to figure out your regular tax bill must be added back. Once you add back in these disallowed credits and run the numbers, you might be subject to a bigger IRS bill if your taxable income exceeds the annual AMT exemption amount for your filing status.
If your income is above the AMT exemption then the alternative minimum tax is usually triggered- meaning you need to calculate your taxes twice. Once under regular tax rules and then under the AMT rule and pay the higher amount owed.
| FILING STATUS | AMT EXEMPTION AMOUNT FOR 2020 |
|---|---|
| Single Individuals | $81,300 |
| Married Filing Jointly | $126,500 |
AMT exceptions also phase out after a certain amount. In 2023, the exemption phases out at $578,150 for single filers and $1,156,300 for married taxpayers filing jointly.
How do you know of you need to pay AMT?
Unfortunately, there’s no easy way to figure out if you’ll be subject to paying the AMT. Everyone’s tax situation is different and what goes into the calculations is uniquely personal. To complicate things, there’s no specific income threshold at which the AMT kicks in.
A good place to start is checking on the IRS website. You can also get a good handle on whether you’ll be subject to AMT or not by using tax-planning software such as TurboTax or TaxSlayer to run projections and monitor your tax liability. Or you can hire a tax accountant to run projections for you.
Another way to estimate if you are close to getting hit with the AMT is to calculate last year’s taxes using Form 6251 and see where your income will fall in relation to them this year.
Bottom line
As a taxpayer, you are required to figure out if you owe any additional tax under the Alternative Minimum Tax system by completing IRS Form 6251. If the tax calculated on Form 6251 is higher than that calculated on your regular tax return, you have to pay the difference as AMT — in addition to your regularly calculated income tax.
If the calculations show you must pay the AMT, paying the extra amount combined with the extra paperwork hassle is not fun. But it’s better than dealing with the IRS if an audit shows that you should have paid and did not. The IRS charges interest on unpaid taxes and assesses penalties.
