What Is the Alternative Minimum Tax, and Who Pays It?
You’ve worked hard to earn a higher income level. But your achievement comes with good news and bad news. The good news is you have the opportunity to enjoy a more comfortable life and hopefully put more money towards your savings and retirement accounts. The bad news? You may be subject to paying extra taxes under the alternative minimum tax (AMT), a whole different tax structure with its own set of rules.
The AMT was enacted by Congress in 1969 to ensure millionaires paid their fair share of taxes at the time, but a surprising amount of Americans earning as little as $71,700 a year today may get caught in its web. Fortunately, Congress has made adjustments to clear things up through the Tax Cuts and Jobs Act (TCJA). It’s still worth taking a closer look at the alternative minimum tax to check if it applies to your situation and what you can do about it.
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Alternative Minimum Tax Definition
The alternative minimum tax (AMT) is an income tax meant to ensure that a select group of tax filers are paying at least a minimum amount of taxes. It prevents high-income individuals from using too many deductions or loopholes to get out of taxation.
Its structure limits the tax deductions the average filer benefits from. Commonly used deductions such as business expenses, personal property taxes paid, and personal exemptions don’t apply. Not being able to benefit from a reduction in adjusted gross income from standard deductions may leave certain filers in a higher tax bracket with a higher income tax liability, compared to a traditional tax filing.
Taxing the Rich
On the Instructions for Form 6251, the IRS explains that the AMT applies to taxpayers “that receive favorable treatment,” by setting limits on the benefits they can use to reduce their taxes. Polls show that most Americans, regardless of political affiliation, want top earners to pay more taxes. And the alternative minimum tax is a step in this direction.
The issue is not all individuals and families subject to the tax are “millionaires.” The tax was never adjusted for inflation, potentially leaving a small number of middle-class individuals and families exposed to its liability.
How Does AMT Work?
The alternative minimum tax works by reducing the number of deductions you’d typically use to drop down your tax liability. Instead, it focuses on your annual income to determine if you fall into the higher income tax bracket that triggers the AMT.
If your yearly earnings are at least $71,700, you may be close to the AMT threshold and should calculate your federal income taxes two times. First, calculate your taxes using the standard IRS rules. Then run numbers following the AMT’s calculation worksheets on the Instructions for Form 6251.
If the process seems complicated, you can always use tax preparation software or ask a tax professional for help in determining if you triggered the AMT and what you will owe.
Who Pays Alternative Minimum Tax?
The Tax Cuts and Jobs Act (TCJA) updated the exemption amounts, so fewer individuals have to worry about being affected. At this time, the upper-middle class pays the bulk of the AMT. The 2019 alternative minimum tax exemptions are $71,700 for single filers and $111,700 for married couples who file jointly.
The exemptions end gradually. Once a taxpayer’s alternative minimum tax income (AMTI) hits the threshold of $510,300 for individual filers and $1,020,600 for married taxpayers who file a joint return, the exemption phases out at an amount of 25 cents per dollar of income.
When Does AMT “Kick In”?
Your odds of encountering the AMT today are lower, but there are conditions that may cause the tax to kick in. Here are a couple of examples:
- Filers living in high-tax states: A study found that residents of California, New Jersey, and New York paid almost half of all the alternative minimum taxes for 2016. That’s because the AMT doesn’t allow the deduction of state and local taxes. California’s state income tax rate is as high as 13.3%. Not being able to deduct such a high amount can push certain taxpayers in high-tax states into the AMT bracket.
- Larger families: Personal exemptions are not allowed in AMT calculations, meaning you can’t reduce your taxable income by the number of dependents you claim on your regular taxes. You may need to make more to support a larger family — but you won’t receive a tax break for your higher income.
AMT Tax Rate
The current AMT tax rates are 26% and 28%. The 26% tax rate applies to taxpayers earning up to $194,800 or married couples who file separate tax returns and make up to $97,400. Surpassing those amounts causes taxpayers to trigger the higher 28% tax bracket.
Tax Tips for Alternative Minimum Tax
The AMT doesn’t allow for many of the standard tax deductions you’re used to when filing your taxes. Therefore, there’s not much you can do to avoid AMT liability. Knowing how AMT works and what causes it to go into effect will help you plan ahead and prepare for filing your taxes. Here are some ideas on how you can save on the amount of tax you may have to pay:
- Work with a tax professional or tax filing software to file your tax return;
- Max out your 401(k), IRAs, or other retirement account contributions to keep your adjusted gross income out of the AMTI range;
- Set a savings and investment goal to build your personal wealth;
- Put funds aside each month towards your potential tax bill, so you don’t have to worry when it’s time to pay.
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