Alternative Minimum Tax (AMT): Definition & Who Pays It?
The Alternative Minimum Tax (AMT) was created in order to prevent high income individuals from utilizing tax-evasion strategies. The AMT, however, was hitting more middle-class taxpayers every year since it was not automatically adjusted for inflation. Prior to passing a permanent “patch” to the AMT in January 2013, Congress has historically issued a yearly “patch” to fix this.
Read on as we take a closer look at everything to do with the alternative minimum tax.
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KEY TAKEAWAYS
- The AMT makes sure that certain taxpayers pay the required minimum. It doesn’t start working until a specific threshold of income is reached.
- The amount for couples filing jointly in 2022 is $118,100 and $75,900 for single filers.
- To protect middle-class taxpayers against tax bracket creep, Congress approved the American Taxpayer Relief Act of 2012. This indexes the exemption amount to inflation.
What Is Alternative Minimum Tax (AMT)?
An alternative minimum tax (AMT) is calculated on the incomes of some high earning individuals by setting a limit on some of the tax lowering strategies.
AMT is calculated in addition to the regular income tax. This tax is calculated regardless of how many credits or tax deductions the filer may claim. AMT has been imposed to ensure that those individuals pay a minimum amount of tax.
The AMT recalculates the income tax by adding back some allowed credits like the general business credit or the qualified EV tax credit. There are other considerations as well that can be figured out by filling out the IRS Form 6251. Some of the credits that need to be added back are if you sold stock options or had a large long term capital gain.
How the Alternative Minimum Tax (AMT) Works
The tax owed on the difference between a taxpayer’s Alternative Minimum Tax Income (AMTI) and their AMT exemption is determined using the applicable rate schedule. As a result, individuals employing tax strategies for high income earners might have to pay the tentative minimum tax (TMT).
If the TMT is greater than the taxpayer’s annual regular tax burden, the taxpayer must pay both types of tax. Specifically, this is the standard tax and the amount by which the TMT exceeds the standard tax. In other words, the taxpayer bears the full cost of TMT.
The AMT exemption increased to $118,100 if married filing jointly and $75,900 for single filers for the tax year 2022. This is after being adjusted to keep up with inflation in 2021, when it was $114,600 for joint filers and $73,600 for individuals.
If the TMT exceeds the regular tax liability for the year, they are responsible for paying both the regular tax and the excess TMT.
What Is the Purpose of Alternative Minimum Tax?
AMT is intended to stop people from using tax benefits to avoid paying a minimum amount of tax.
How to Calculate Alternative Minimum Tax
People can use tax software that automatically calculates the AMT or complete IRS Form 6251 to determine whether they owe it. This form helps tax filers evaluate whether their itemized deductions go over an overall IRS cap by taking into account medical costs, house mortgage interest, and a number of other supplemental deductions. Claiming itemized deductions may be more beneficial in avoiding paying AMT even if the deductions are lower than the standard deduction.
In order to calculate your AMT, you take your ordinary income from form 1040, add back certain income, deduct certain deductions and other tax breaks. Deduct your AMT exemption, multiply by the AMT tax rate and compare the amount to the amount you would owe under the regular tax calculation. You will have to pay the higher amount of the two.
Why am I Paying the Alternative Minimum Tax?
Examining your Form 6251 from the previous year is the quickest approach to determine why you are paying the AMT or how close you were to doing so.
- To determine how close you came to paying the AMT, compare the Tentative Minimum Tax to your usual tax (the Tentative Minimum Tax should be the line above your regular tax).
- Check lines 2 and 3 for any entries that modify your taxable income for AMT purposes. For instance, you must add a number of items back into your income. This includes your standard deduction, taxes deducted on Schedule A, the bargain portion of any exercised incentive business stock options, as well as several investment-related items.
How to Escape the Alternative Minimum Tax
A great strategy to lower your AMT burden is to maintain your adjusted gross income (AGI) so that it is as low as is practical. Several possibilities to achieve this include:
- Contribute as much as you are able to through salary deferral to your SIMPLE IRA, 401(k), 403(b), SARSEP, or 457(b) plan. By making tax-deductible contributions to 401(k)s or other qualified retirement plans, self-employed workers can also reduce their AGI.
- Before taxes, make contributions to flexible spending accounts. There are also some FSAs that can be utilized for health savings insurance and assistance with child care.
- Using employer-sponsored cafeteria programs to pay for additional expenses like life insurance on a pre-tax basis will lower your taxable income.
- Organize the items in your taxable investment portfolio. It may be a better idea to switch to other means. Such as tax-efficient mutual funds and tax-exempt bonds or bond funds, for example. This can help to effectively reduce your AGI.
- Keep track of the dates that particular payments are due. Prepaying municipal income taxes, real estate taxes, or inheritance taxes, for example, can reduce your ordinary tax liability, but the expenditure is subject to the AMT. Don’t do it only to gain a small discount for paying early if paying your 2022 real estate expense in 2021 will result in or increase your AMT liability for 2021.
- Any AMT liability may be reduced by using nonrefundable personal tax credits, such as dependent care and overseas tax credits. A minimal tax credit can also be available to you if you had previously paid AMT.
Summary
The Alternative Minimum Tax (AMT) was created in order to ensure that high income earners pay a minimum tax on their earnings. The AMT was affecting more middle-class taxpayers every year, because it was not automatically adjusted for inflation. This was remedied by the tax act of 2012.
FAQS on Alternative Minimum Tax
A great strategy to lower your AMT burden is to keep your adjusted gross income (AGI) as low as is practical.
According to the tax code, some tax incentives can considerably lower a taxpayer’s ordinary tax obligation. By putting a cap on those advantages, the alternative minimum tax (AMT) is applicable to people with significant economic income. By doing this, it is made possible for such taxpayers to make at least a minimum tax payment.
By putting a cap on some tax advantages, the alternative minimum tax (AMT) is applicable to people with significant economic income. By doing this, it is made possible for such taxpayers to make at least a minimum tax payment.
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