What is the alternative minimum tax or AMT?
What is AMT?
The alternative minimum tax is applied to certain high earners for certain types of income that they have during a tax year. It involves a recalculation of income tax after certain tax items are added back into your adjusted gross income.
This progressive tax places a higher tax rate on those with greater incomes and is based on the ability to pay. It was started to prevent wealthy taxpayers from taking advantage of excessive deductions in an effort to avoid paying taxes.
The AMT includes other income that is not accounted for by the regular income tax. Some of the income that might trigger the alternative minimum tax include the following:
- Fair market value of incentive stock options that were exercised but not sold
- Interest earned from private activity bonds
- Foreign tax credits
- Passive income
- Losses and net operating loss deductions
Who has to pay the alternative minimum tax?
Taxpayers who might have to pay the alternative minimum tax include those whose income exceeds the exemption amount for their filing statuses. The tax rates are 26% for the income below the exemption level and 28% for the income that is above it.
The 28% AMT rate applies to excess alternative minimum tax income of $194,800 for all taxpayers or $97,400 for married couples who file separately. Factors that might increase your likelihood of having to pay the alternative minimum tax is having substantial deductions for the following items:
- State and local income taxes
- Interest on second mortgages and home equity loans that were used for purposes other than improving your home
- Miscellaneous itemized deductions
- Medical expenses
If you believe that you might have to pay the alternative minimum tax, it is important for you to learn how you might be able to avoid it through careful tax planning.
During the latest tax year for which data is available, the IRS reports that over 4.6 million taxpayers filed returns that included alternative minimum tax at a total collected amount of slightly more than $31 billion. Of those returns, over 15,000 were filed by people who had reported regular income of less than $15,000 for a total amount of slightly more than $160 million.
This is important to recognize because people who have a large capital gain that far exceeds their ordinary income may be subject to the alternative minimum tax even if their regular incomes are negligible. For those households, it means that they enjoyed capital gains and other types of alternative income in large enough amounts to trigger the tax.
Alternative minimum tax history
Before the passage of the Tax Cuts and Jobs Act, the minimum tax primarily impacted those who were well-off but not especially the people who earned the highest incomes. At that time, the tax was likelier to impact people who were married, people who lived in high-tax states, and people who had large families.
The TCJA retained the alternative minimum tax. It raised the AMT exemption from $54,300 to $70,300 for single taxpayers and from $84,500 to $109,400 for joint taxpayers. The phase-out for the exemptions begins at $500,000 for single people and $1 million for joint filers. In 2026, the exemptions will return to their pre-TCJA levels.
The TCJA reduced the number of taxpayers who must pay the AMT. It also included multiple revisions that eliminated some exemptions and itemized deductions. The TCJA eliminated the personal exemptions and the ability to take itemized deductions for employment-related and miscellaneous expenses. It also raised the standard deduction and capped the state and local tax deduction at $10,000.
Congress eliminated the corporate minimum tax but not the minimum tax for individual taxpayers. The intent of the TCJA was to boost the economy and to increase revenue. However, since the exemptions will return to their pre-TCJA levels in 2026, many of the tax benefits for individuals from the TCJA will disappear in a few years.
Who does the alternative minimum tax apply to?
The AMT tax applies to people whose adjusted gross incomes are higher than the exemption. It still often impacts married taxpayers who have higher incomes and several children. This is due to the fact that the tax does not allow additional exemptions for each household member or a marriage bonus.
To figure out whether the tax applies to you, you can talk to a tax professional or use a tax program. You can also use Form 6251 from the IRS to figure out if you are subject to the tax.
Alternative minimum tax calculation
According to the IRS, the tax is the how much your tentative minimum tax exceeds the regular tax. You figure your tentative minimum tax separately from your regular tax. You can calculate it by following these steps:
- Compute your taxable income while you eliminate or reduce certain deductions and exclusions
- Subtract the exemption amount
- Multiply the amount that you calculated in step 2 by the applicable alternative minimum tax rates
- Subtract the foreign tax credit
You will owe the AMT if your tentative minimum tax amount is greater than your regular tax amount.
When you calculate your Alternative Minimum Tax Income, or AMTI, you are not permitted to take many different types of itemized deductions against your minimum tax. The disallowed deductions include the following:
- State and local income taxes
- Medical expenses
- Mortgage interest on home equity debt
- Accelerated depreciation
It is very important for you to follow the IRS form carefully or to use a tax program to benefit from the latest deductions.
Alternative minimum tax exemption
The AMT exemption is similar to a standard deduction for the AMT. It can reduce your AMTI when you claim the exemption amount. It is larger than the standard exemption and is adjusted with inflation every year.
Currently, the AMT exemption amounts for unmarried individuals is $71,700. For people who are married filing jointly, the exemption amount is $111,700. Once you reach a certain level of income, the exemption begins to phase out. After it hits this level, the exemption is reduced by $0.25 for every dollar above the phase-out level. Recall that in 2026, the exemptions will return to their pre-TCJA levels.
Currently, the exemption begins to phase out at $510,300 in AMTI for single filers and $1,020,600 for married taxpayers who file jointly.
If you do not have to pay the AMT this year but have paid it in a previous tax year, you may be eligible to take a special minimum tax credit against your regular tax this year. If you are eligible to do so, you will need to complete and attach Form 8801 to your tax return to claim the minimum tax credit.
Avoiding the alternative minimum tax
Fortunately, it is possible for you to avoid the AMT with a careful tax plan. Since it is a progressive tax, you can work to lower your adjusted gross income by maxing out your contributions to your retirement accounts, including your Roth IRA, 401(k), traditional IRA, or health savings account. If you are age 50 or older, take advantage of the catch-up contributions.
You can also move money into an IRA from an individual or joint account for tax savings. Move your investment dollars into a tax-deferred account. Make sure to follow annual contribution limits and rules when doing so.
A health savings account may allow you to pay for certain medical expenses on a pre-tax basis. A flexible spending account is another way that may allow for you to pay for child care expenses on a pre-tax basis. These accounts are both funded with pre-tax contributions. Using FSA and HSA accounts lowers your gross income and helps to reduce both your regular tax and your AMT.
Your tax plan might include reducing your itemized deductions and increasing your charitable contributions. You might want to focus on long-term capital gains instead of short-term gains. This means that you should try to hold your securities for at least a year or longer before you sell them. When you do sell your high-producing capital assets, try to time it for a year in which your income is lower. Harvest your losses to offset your realized capital gains.
Choose to invest in exchange-traded funds or ETFs. They typically will not have capital gains until you sell your shares. Move the investments that you have that generate ordinary income to an IRA or another qualified account such as a bond fund or a real estate investment trust.
Sell your exercised incentive stock options in the same year. If you do not sell the options that you have exercised, their value becomes income for AMT purposes. Steer clear from private activity bonds. The interest earned from them is taxable under the rules, increasing your exposure.
A company reimbursement can also help. Ask your employer if it can reimburse some of your large, unreimbursed employee expenses instead of deducting them on your taxes. If you are self-employed, use Schedule C for your deductions instead of claiming them as miscellaneous deductions. If you are eligible, take the home office deduction.
Check to make certain that your state tax withholding is not higher than your expected payment. You cannot deduct state tax payments under the AMT.
Do not prepay your property taxes, and only pay them when they are due. You are not permitted to deduct your state and local income taxes and property taxes under the AMT rules. It makes sense to wait to pay them next year when you might be able to avoid being in the range.
Following the passage of the Tax Cuts and Jobs Act, the itemized deductions for state and local income and property taxes are limited to a combined total of $10,000 through 2025. If you prepay those taxes, you might be pushed into a level where you will be unable to deduct them.
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Holding your securities for the long-term instead of realizing your capital gains now can help you in your efforts to avoid the AMT. M1 Finance can help you to minimize your taxes by using strategies for tax efficiency in your investment accounts.
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Tax and Legal Advice Disclaimer. M1 Finance and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.