The Alternative Minimum Tax: What You Should Know
September 26, 2019 in Tax Info
The Alternative Minimum Tax (AMT) is a somewhat controversial tax. This separate tax was designed to ensure that higher income individuals pay their fair share of taxes. However, for many years, this tax was never adjusted for inflation. This meant that, over the years, more middle class earners became subject to the AMT. But the Tax Cuts and Jobs Act (TCJA), which went into effect this past tax year, made significant changes to AMT laws. These changes dramatically reduced the amount of people who will be subject to the AMT.
So, how does the AMT affect you? Are you subject to the AMT after the TCJA changes? Read on to learn everything you need to know about what the Alternative Minimum Tax is, how it’s calculated, and how the TCJA changed the AMT.
What is the Alternative Minimum Tax?
The Alternative Minimum Tax was put into place in 1969. The AMT was designed to address a specific issue: high income taxpayers who were paying little to no tax by using various legal tax strategies, like credits and deductions.
The AMT is technically a separate tax from income tax. However, those who are subject to the AMT need only pay one of these tax liability amounts (whichever is higher). If a person’s income tax liability is higher than their AMT, they would pay only their income tax amount. If a person’s income tax liability amount is lower than their AMT amount, they would pay their income tax liability and the difference between their income tax liability and AMT (so, in essence, they would pay their AMT amount).
The AMT applies to those over certain income amounts. However, there are also certain types of deductions that trigger the AMT, regardless of income. Some of “red flag” deductions that will trigger the AMT include accelerated depreciation, investment expense, and net operating loss deduction. But there are actually dozens of deductions that will trigger the AMT. So, if you are a higher income earner that usually takes a lot of deductions, we generally recommend having a tax professional prepare your return. This will ensure that you only pay the AMT if absolutely necessary.
How is the Alternative Minimum Tax Calculated?
Calculating the AMT is rather complicated. To determine the AMT, higher income taxpayers must take their regular income amount and add on certain disallowed credits and deductions to come up with their alternative minimum taxable income (AMTI). Some disallowed credits and deductions include state and local tax deductions, foreign tax credits, the standard deduction, personal exemptions, home equity mortgage interest, and bargain elements of any incentive stock options.
Once a taxpayer has determined their AMTI, they must then subtract their allowed exemption amount (which is based on the total AMTI amount). Then, finally, multiply that amount by their applicable AMT percentage to determine their AMT amount.
How did the Tax Cuts and Jobs Act Affect the Alternative Minimum Tax?
Finally, let’s take a look at how the Tax Cuts and Jobs Act changed the Alternative Minimum Tax. Over the years, the AMT has affected more middle class earners, since this tax was never officially tied to inflation. The government has made numerous “patch” changes to the AMT to address this issue each year. But, still, if the TCJA had not changed the AMT, it’s estimated that 20% of taxpayers would have paid the AMT by 2020 (up drastically from the approximately 1% of taxpayers who originally paid this tax).
The TCJA dramatically reduced the amount of Americans who are subject to the AMT. It did this by significantly increasing the AMT exemption and its correlating phase out range. These changes mean that far fewer middle class earners will be subject to the AMT. The AMT now largely applies only to very high income earners. Additionally, while the AMT has applied to corporations in the past, the corporate AMT has now been repealed.
While the AMT will now affect far fewer Americans, it is still in place for some. If you’re among the taxpayers who are still subject to the AMT, we recommend hiring a professional to prepare your taxes. The AMT now applies to fewer taxpayers but it’s still an enormously complicated tax. Hiring a tax professional to calculate your AMT amount can help ensure you don’t miss a single applicable AMT exemption so you don’t pay the IRS a penny more than you owe.