Alternative Minimum Tax

Published Mar 21, 2024

Definition of Alternative Minimum Tax (AMT)

The Alternative Minimum Tax (AMT) is a supplementary income tax imposed by the United States federal government in addition to baseline income tax for certain individuals, corporations, estates, and trusts. The AMT is designed to ensure that certain taxpayers with access to advantageous tax benefits or deductions pay at least a minimum amount of tax. It aims to prevent the wealthiest individuals from using these benefits to drastically reduce or eliminate their tax liability.

How AMT Works

The AMT calculation starts by taking the taxpayer’s regular taxable income and adding back in various preferences and adjustments to calculate the Alternative Minimum Taxable Income (AMTI). From the AMTI, the taxpayer then subtracts an exemption amount (which phases out at higher income levels) to arrive at the taxable income under AMT. The taxpayer computes the tax liability at the AMT rates (26% for amounts up to a certain limit and 28% for amounts above that), subtracts any AMT foreign tax credits, and compares this amount to their regular tax liability. If the AMT is higher, the taxpayer must pay the difference in addition to their regular tax.

Example

Consider a high-earning individual with significant deductions that substantially lower their regular tax. This person might have a regular tax liability of $30,000. However, when calculating the AMTI, many of these deductions are not allowed, resulting in an AMTI much higher than the regular taxable income. After applying the AMT exemption and computing the tax at the AMT rates, the individual might have an AMT liability of $35,000. In this case, the individual would need to pay an additional $5,000 to meet the AMT requirements.

Why AMT Matters

The AMT is a critical tool in the U.S. tax system’s aim to promote fairness by ensuring that all taxpayers contribute a baseline level of tax, especially those who would otherwise benefit excessively from deductions and exclusions. While it has been subject to criticism for ensnaring more middle-income earners than initially intended, adjustments and exemptions have been made over time to address these concerns. The Tax Cuts and Jobs Act of 2017 temporarily increased these exemptions and phase-out thresholds, reducing the number of taxpayers affected by AMT until 2025.

Frequently Asked Questions (FAQ)

Who is liable to pay the AMT?

Taxpayers who have a high income and take large numbers of deductions, exemptions, and other tax benefits that significantly lower their effective tax rate may be subject to the AMT. Each year, taxpayers must calculate their tax liability under both the regular tax system and the AMT system and pay whichever is higher.

What adjustments and preferences increase AMTI?

Common adjustments that increase AMTI include state and local tax deductions, certain interest on home equity loans not used for home improvement, depreciation adjustments, and various exclusions for foreign income. Personal exemptions and the standard deduction are not applicable under AMT calculations.

Can the AMT be avoided or reduced?

Taxpayers might avoid or reduce AMT liability through careful tax planning that takes into consideration potential AMT triggers. Strategies can include timing state and local tax payments, avoiding short-term tax-exempt bonds, and managing capital gains. However, the complexity of the AMT requires a nuanced approach, often involving the assistance of a tax professional.

What is the future of the AMT?

Discussions about the AMT’s future often revolve around its complexity, its reach into middle-income brackets, and its effectiveness in fulfilling its original purpose. While there have been adjustments, such as those made by the Tax Cuts and Jobs Act, the future of the AMT depends on further legislative actions which could potentially reform or abolish the tax in response to ongoing debates about tax equity and complexity.