Q: What is AMT?
A: Alternative Minimum Tax (AMT) is an alternative tax system started in 1969 due to a few high-income taxpayers who were paying hardly any tax due to various tax deductions and other loopholes. But because it was never indexed for inflation, even middle-class taxpayers have been subject to AMT. This tax system disallows certain deductions, the most common of which are property and state tax, has its own exemption, and then applies a tax rate starting at 26%. Your regular tax is then compared to the AMT, and whichever is higher is what you’ll pay.
Q: How do I know if I have to pay it?
A: You may be subject to AMT if you have adjusted gross income of $75,000 or more. It will also depend on the amounts of your various disallowed deductions and other add-backs, known as adjustments and preference items. This is all reported and calculated on Form 6251, when you prepare your tax return. The AMT is a complicated calculation, and the IRS has an AMT calculator to help you estimate whether you’ll have AMT or not.
Q: What is the AMT patch that I read about?
A: Because AMT is not indexed for inflation, every year more and more taxpayers are subject to AMT. To counteract this, for the past few years, Congress has included in various tax acts, a “patch” which increases the AMT exemption amount for that particular year. Thus, more taxpayers will escape some or all of AMT. The 2010 and 2011 patches were done concurrently; however, Congress has not yet passed a 2012 patch.
Q: Is there any way to avoid it?
A: If you have large differences in either income or the disallowed deductions between years, if you have the flexibility to either pay property or state taxes in one year vs. the other you may be able to reduce or eliminate AMT for a particular year. Tax planning may help in making this determination.
Also, be alert to the timing of exercising incentive stock options, as the difference between the exercise price and the fair market value of the stock on the day of the exercise is an add-back for AMT purposes. Basically, you are going to be subject to AMT on the phantom profit on the day of exercise.
Although it is often recommended that you pay property and state taxes early in order to get the additional deduction, if you are in AMT there is no benefit to doing this, so you might as well hold on to your money for the extra time.
If you have additional questions on how an AMT might affect your personal tax situation, please contact us.
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