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Alternative Minimum Tax (AMT): Definition & Who Pays It?

Updated: November 23, 2022

The Alternative Minimum Tax (AMT) was created in order to prevent rich 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 or at least their fair amount.
    • It doesn’t start working until a specific threshold of income is reached. 
    • The amount for couples filing jointly in 2022 is $118,100.
    • 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) lowers the minimum amount of taxes that a filer must pay to the government. This is regardless of how many credits or tax deductions the filer may claim.

    For taxpayers who earn more than a particular amount, the US now has an alternative minimum tax.

    The AMT recalculates income tax. This is after reentering specified tax preference items into adjusted gross income. AMT calculates taxable income after permitted tax deductions. Although this is according to a different set of criteria. The taxpayer’s alternative minimum taxable income (AMTI) is calculated by adding back preferential deductions. The AMT exemption is then reduced to arrive at the final taxable amount.

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    How the Alternative Minimum Tax (AMT) Works

    The tax owed on the difference between a taxpayer’s AMTI and his AMT exemption is determined using the applicable rate schedule. As a result, there could be a minimal 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 and $75,900, respectively, 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 their fair share of taxes.

    However, neither tax reductions nor inflation was linked to the framework. As a result, there may be a circumstance known as “bracket creep”. This is in which upper-middle-class taxpayers as well as the wealthy taxpayers for whom the AMT was designed are liable to this tax. But in 2012, Congress approved a measure that indexed the AMT exemption sum to inflation.

    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.

    Along with asking for information on specific types of income like tax refunds, investment interest, and bond interest, the form also asks for numbers that represent capital gains or losses tied to the sale of a property. The IRS employs a different set of formulae to establish how these figures add up to AMTI. It uses a set of specialized formulas to decide which portion of this income and deductions the tax filers must note on Form 6251.

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    Why Pay 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 prevent wealthy individuals from utilizing tax-evasion strategies. The AMT, however, was hitting more middle-class taxpayers every year. This is because it was not automatically adjusted for inflation.

    The fact that Congress was effective in making it challenging to avoid this tax is one of the positive things that can be said about the AMT. You must comprehend how the AMT varies from the standard tax system in order to avoid paying the AMT.

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    FAQS on Alternative Minimum Tax

    How Can I Avoid Paying AMT?

    A great strategy to lower your AMT burden is to keep your adjusted gross income (AGI) as low as is practical.

    What Is AMT Taxable Income?

    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.

    What Is the Purpose of AMT?

    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.

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