Understanding the Alternative Minimum Tax

More and more people each year are subject to the AMT: Know the rules.

Everybody who earns a good income should pay at least some federal income tax. This is the idea behind the alternative minimum tax (AMT), one of the most complicated and dreaded parts of the tax law.

Congress created the AMT in 1969, targeting higher-income taxpayers who could claim so many deductions they owed little or no income tax. However, because the AMT is not indexed for inflation, a growing number of middle-income taxpayers are discovering they are subject to it. The number of taxpayers owing the AMT grew from about 20,000 in 1970 to about four million in 2011.

The AMT is designed to force taxpayers to pay a minimum amount of tax, even if they are required to pay less, or no tax at all, under the regular tax system. If you’re required to pay the AMT, you pay it in addition to your regular income taxes.

The AMT is in effect a separate and parallel tax system that is figured separately from regular income tax. The AMT eliminates or reduces many exclusions and deductions you're allowed under the regular income tax laws. In addition, certain credits (generally, business-related credits) cannot be used to offset the AMT. Thus the AMT increases the tax liability of people who would otherwise pay less tax.

You’re most likely to be subject to the AMT if you have an income over $100,000 or have an income of at least $75,000 and have many exemptions and deductions that are not allowed for the AMT. For example, you:

  • have lots of children—each one provides a dependency exemption not allowed for with the AMT
  • have substantial capital gains--for example, from the sale of stock or property
  • live in a state with high income taxes like New York or California
  • have substantial miscellaneous itemized deductions, such as unreimbursed employee expenses or investment expenses
  • have a very large medical expense deduction
  • pay substantial interest on a home equity loan and don’t use the money to improve your home or buy or improve a second home, or
  • receive stock options from your employer.

However, a specific amount of taxable income is exempt from the AMT each year. You won't have to pay the AMT if your taxable income for regular tax purposes is less than the AMT exemption amount.

Form 1040 has a question that asks whether you must pay AMT. Therefore, everyone who files is forced to figure out whether or not they are subject to AMT. The IRS has an AMT Assistant on its website (www.irs.gov) that you can use to see if you might be subject to the AMT. The AMT is so complicated, the only way to determine if you're subject to it is to run the numbers.

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