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. (To continue reading about taxes, see Tax Tips For The Individual Investor.)
Tutorial: Personal Income Tax Guide
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 33%, 35% and 36.9%), 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%, 15% and 25%) 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
For 2015, 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 2015:
- Single: $71,700
- Married filing jointly or qualifying widow: $111,700
- Married filing separately: $55,850
Note: A special exemption applies to a child subject to the “kiddie tax” on unearned income. For 2015, the exemption is the sum of the child’s earned income plus $7,400; this amount cannot exceed the exemption that would otherwise apply (e.g., $53,600 for a single person, including a child).
The exemption amount begins to phase out when AMTI exceeds in 2015:
- Single: $119,200
- Married filing jointly or qualifying widow: $158,900
- Head of household: $119,200
- Married filing separately: $79,450
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 2020 real estate bill in 2019 in order to obtain a small discount for paying early if doing so triggers or increases AMT liability for 2019.
- 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.
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.