Back in the day, the Alternative Minimum Tax (AMT) was enacted as an alternate form of federal income taxation to ensure that wealthy individuals pay a fair share of federal income taxes. Today, AMT often extends beyond the wealthy, causing many middle income taxpayers to be subject to AMT. In fact, many wealthy taxpayers are not subject to AMT due to an increase in the top marginal regular tax rate that took effect beginning in 2013 which causes their regular income tax to be higher than their AMT.
As a Federal taxpayer, you are subject to a dual tax system. AMT works in parallel with the regular federal income tax and includes certain tax-free income and disallows many deductions. Taxpayers are required to calculate their tax liability using both systems and pay the higher of the two. Are you snakebit yet?
The AMT might take a bite if you’re an upper-middle-class taxpayer with income between $200K and $500K. AMT might also apply if you have substantial amounts of the following that are not subject to regular income tax:
- Exempt Interest from specified private activity bonds.
- Income from the exercise of incentive stock options (ISO’s) that was deferred for regular income tax (the bargain element).
- AMT gain adjustments from the disposition of property.
- AMT depreciation adjustments.
In addition, AMT does not allow many of the deductions and exemptions available under regular tax such as –
- Personal and dependency exemptions
- Standard deduction (if not itemizing)
- If itemizing –
- A portion of your deductible medical expenses up to 2.5% of adjusted gross income if you or your spouse are over 65
- State and local taxes paid, including income, sales, real estate, personal property and foreign income taxes
- Interest on second mortgages and home equity loans used for purposes other than home improvement
- Miscellaneous deductions
Here’s how AMT is calculated:
- The above preference items are added to regular income to derive alternative minimum taxable income (AMTI)(If you are married filing separately, AMTI may need to be increased if above certain amounts).
- Your AMT exemption amount is then subtracted from AMTI. (The 2014 exemption amounts are $52,800 single/head of household, $82,100 married filing jointly, $41,050 married filing separately – these amounts are indexed for inflation on an annual basis).
- Any excess of AMTI over the exemption amount is subject to AMT rates ranging between 26% and 28%, as adjusted for any capital gains tax and any AMT foreign tax credit to arrive at tentative minimum tax.
- Your tentative minimum tax is then compared to the regular tax and any excess over the regular tax represents the AMT and is added to regular tax to determine your total tax liability.
It is not uncommon, therefore, for a large two-earner middle class family to be subject to AMT by merely adding back to income their personal and dependency exemptions, state and local tax withholdings, real estate taxes and interest on a second mortgage that was used to buy a car and pay for the family vacation. If you can identify with this scenario, then you are officially snake bitten.
How You Can Minimize AMT
If you tend to fall into cycles where there are years that you are not subject to AMT, consider bunching the payment or recognition of some of the AMT preference items into non-AMT years. In the end, proper tax planning is essential to reducing exposure to AMT’s impact.
For further tips to minimize your AMT exposure.
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To find out more about minimizing the impact of AMT, please contact Victor C. Belgiorno at 516-861-3704 or or Bob Jahelka at 516-861-3707 or .