Are You Now Safe From the Alternative Minimum Tax?

Did you know that you’re supposed to calculate your income taxes two different ways?

First, you figure your tax liability under the regular tax system, which factors in preferential treatment of some income and allows tax credits for certain types of expenses. Then you calculate your taxes using the rules for the alternative minimum tax (AMT), which eliminates some tax deductions and credits. If the AMT is higher, you will be subject to taxes in addition to your regular income tax. Read on to learn more about reducing your AMT.

Key Takeaways

  • The alternative minimum tax (AMT) ensures that certain taxpayers pay their fair share of income taxes.
  • However, the structure was not indexed to inflation or tax cuts. This can cause bracket creep, a condition in which upper-middle-income taxpayers are subject to this tax instead of just the wealthy taxpayers for whom AMT was invented.
  • For those subject to AMT, there are certain strategies that can be employed to reduce your exposure to this tax.

What Is the AMT?

The alternative minimum tax, or AMT, was instituted in the late 1960s to ensure that high-income individuals pay at least a minimum amount of federal income tax. The AMT is like a shadow tax because it has its own rules about deductions, its own exemptions, and its own tax rates of 26% and 28%. The AMT is paid only when it results in a higher tax than income taxes figured the regular way (before any tax credits).

Should You Worry About the AMT?

Your chances of paying this tax increase if you:

  • Have a large family. Personal exemptions are not deductible for AMT purposes.
  • Live in an area with high real estate taxes and/or high state and local income taxes. Itemized personal taxes are not deductible in calculating your income for AMT purposes.
  • Claim significant miscellaneous itemized deductions, including investment expenses or unreimbursed employee business expenses. Miscellaneous itemized deductions are not deductible for AMT purposes.
  • Exercise and hold incentive stock options (ISOs). While exercising ISOs has no impact for regular tax purposes, the spread between the purchase price and the grant price is includible in income for AMT purposes.
  • Hold private activity bonds. While interest on these bonds (other than bonds issued in 2009 and 2010) is exempt from regular income tax, it is taken into account for AMT purposes.

Will You Owe the AMT?

There’s no way to know whether you owe the AMT by guessing because there are so many factors that come into play. These include the types of income and expenses you have and your filing status. If your regular tax bill puts you into a tax bracket higher than 28% (higher tax brackets are 32%, 35%, and 37%), you won’t owe AMT because you’re already paying more in regular taxes. But don’t assume that because you fall into a tax bracket below the AMT tax rates of 26% and 28% (10%, 12%, and 22%) that you are free from the AMT.

Adjustments to your income for regular tax purposes may increase your AMT exposure. Those in the 28% tax bracket for regular tax purposes also need to see whether their AMT computations produce a higher overall tax bill than under the regular tax rules.

Exemption Amounts for AMT

You can reduce your income for AMT purposes (technically called alternative minimum taxable income, or AMTI) by an exemption amount. This may reduce or eliminate your AMT exposure. As with many tax rules, the exemption amount depends on your tax status. The following are exemption amounts for 2023:

  • Single: $81,300 ($75,900 in 2022)
  • Married filing jointly or qualifying widow: $126,500 ($118,100 in 2022)

The exemption amount begins to phase out when AMTI exceeds the below amounts in 2023:

  • Single: $578,150 ($539,900 in 2022)
  • Married filing jointly or qualifying widow: $1,156,300 ($1,079,800 in 2022)

A special exemption applies to a child subject to the “kiddie tax” on unearned income. For 2022, the exemption is any amount below $2,200. The first $1,150 is not taxed ($1,250 for 2023). The next $1,150 is taxed at the child's marginal tax rate. If above this amount, the unearned income is to be taxed at the parent's tax rate.

Filling Out Form 6251

To determine whether you are subject to the AMT, you will need to complete Form 6251. 

How to Reduce the AMT

A good strategy for minimizing your AMT liability is to keep your adjusted gross income (AGI) as low as possible. Some options:

  • Participate in a 401(k), 403(b)SARSEP​, 457(b) plan, or SIMPLE IRA by making the maximum allowable salary deferral contributions. Self-employed individuals can also make tax-deductible contributions to 401(k)s or other types of qualified retirement plans to reduce their AGI.
  • Make pre-tax contributions to flexible spending accounts. There are FSAs for health coverage and dependent care assistance.
  • Use employer-sponsored cafeteria plans to pay for other expenses, such as life insurance, on a pretax basis and reduce your taxable compensation accordingly.
  • Reposition investment holdings that are in your taxable investment portfolio. For example, consider switching to tax-efficient mutual funds and tax-exempt bonds or bond funds as a way to decrease your AGI.
  • Watch the timing of certain payments. For example, while prepaying real estate taxes or estate and local income taxes may save on the regular tax, it can cost if subject to the AMT. So don’t pay your 20223 real estate bill in 2022 to obtain a small discount for paying early if doing so triggers or increases AMT liability for 2022.
  • Take tax credits. You can offset any AMT liability by nonrefundable personal tax credits, such as the dependent care credit, and the foreign tax credit. You may also qualify for a minimum tax credit if you paid AMT in prior years.

What Triggers the Alternative Minimum Tax?

An individual's or married couple's income above the alternative minimum tax exemption amounts is what triggers the alternative minimum tax. This typically applies to higher earners. The AMT is 26% or 28%. Individuals need to calculate their tax twice; once by the traditional method of calculating taxes and then by the AMT method, and then pay whichever tax is higher.

What Are the 2023 Exemption Amounts for the Alternative Minimum Tax?

For 2023, the exemption amounts for the alternative minimum tax are $81,300 ($75,900 in 2022) for single filers and $126,500 ($118,100 in 2022) for married couples filing jointly.

How Do I Know If I Need to Pay the AMT?

You will only have to pay the AMT if your income is above the exemption amounts. You will determine this by calculating your taxes in the traditional way and then by the AMT method. You will pay whichever tax is higher. This only really impacts high earners.

The Bottom Line

Calculating your AMT, or even determining whether you are in fact subject to it, is complicated. This article is just an introduction to the subject matter and cannot give you a complete understanding of AMT and how it may affect your taxes.

Unless you are an expert at tax preparation and have a complete understanding of how the AMT works, it may be advisable to have your tax return prepared, or at least reviewed, by an expert tax professional who will be able to determine whether you owe the AMT, are eligible for exemptions, and are eligible to claim AMT credits for any year—including previous years.

Article Sources
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