How the AMT works
Posted On: 9-4-2015 | Posted By: Kirk Duncan, CPA
Have you been required to pay the Alternative Minimum Tax, or AMT, in the past? It’s a tool used to ensure taxpayers with higher incomes pay at least a minimum amount of income tax. If you’ve been subject to the AMT in the past, or might be in the future, read on for a primer on the subject.
Why the AMT was created
Over the years, Congress has used an increasing number of special tax provisions to promote economic and social goals. These provisions give preferential treatment to certain kinds of income and allow for special deductions for certain expenses. In the past, the use of these provisions allowed taxpayers to substantially reduce or eliminate their entire income tax liability. In 1969, a Treasury Department study revealed that a number of wealthy individual taxpayers had paid no federal income tax in 1966. In response to the backlash, Congress enacted a new set of rules to ensure that all taxpayers would pay at least a minimum amount of income tax. The Alternative Minimum Tax was born.
The present AMT system was created in 1978 and is a separate and parallel system to the regular income tax. It was designed to increase the tax bill of taxpayers who take undue advantage of special provisions allowed under the regular income tax to avoid significant tax liability. The basic mechanism by which the AMT accomplishes its objective is by treating certain items less favorably than they are treated for purposes of the regular tax.
Taxpayers are first required to compute their regular income tax liability and then recompute their tax under the AMT system. The AMT calculation is entered on Form 6251, which is attached to a taxpayer’s Form 1040. The AMT requires taxpayers to adjust their regular taxable income by a number of adjustments and preferences and then subtract an exemption amount to arrive at the AMT base. The AMT base is then multiplied by special rates (26% or 28%) to compute the tax, which is called the Tentative Minimum Tax (TMT). Taxpayers are required to pay the greater of the regular income tax or the alternative minimum tax.
The AMT was in the news in recent years because the income thresholds of the tax had not be indexed to inflation and was affecting more and more middle class taxpayers every year. This was “fixed” by the American Taxpayer Relief Act of 2012, which was signed into law in 2013 and indexed the income thresholds to inflation.
Adjustments and preferences
Common adjustments and preferences include the following items.
State and Local Tax Deduction. No deduction is allowed for state and local income taxes, real estate taxes, or personal property taxes under the AMT system.
Personal and Dependency Exemptions. These are not allowed. You must add them back to your regular taxable income in determining AMT income.
Miscellaneous Itemized Deductions. No deduction is allowed for miscellaneous itemized deductions. Employees with large unreimbursed business expenses and taxpayers with large investment expenses are likely to be impacted.
Standard Deduction. If you take the standard deduction instead of itemizing, you must add back the deduction to determine AMT Income.
Depreciation Deductions. For certain depreciable property, the depreciation schedules are slower for AMT purposes than for regular tax purposes. Therefore, some adjustments will need to be made for depreciation, and in the gain/loss on the sale of the property.
Comparing the two tax calculation methods
Your WK advisor can handle these calculations for you and answer any questions you might have. Contact us at (573) 442-6171 or (573) 635-6196 for more information.