We all want to ensure that we’re not paying more than our fair share of taxes each year. But on the flip side, the IRS also wants to make sure that nobody is getting away with so many deductions that they’re not paying enough.
The Alternative Minimum Tax plan was initially implemented in 1969 to ensure that taxpayers with financial savvy (or well-paid accountants) weren’t exploiting so many deductions that they ended up paying little or no taxes.
However, over the years the AMT limits have not risen as fast as inflation. Many more people are potentially subject to AMT taxes these days, so it’s essential to double-check whether you may owe additional taxes if you fall under the AMT rules.
How does the Alternative Minimum Tax plan work?
The AMT is not an additional tax but instead a different way of calculating how much you owe in income tax. When you do your taxes each year, you’re allowed various deductions and credits that reduce the amount you have to pay in income tax. However, the common method of determining your income tax amount is just one way to do it – you can also use the Alternative Minimum Tax method of determining your income tax amount. If the alternate method comes up with a higher figure, you’ll have to pay that.
Most income tax programs will automatically calculate for you whether or not you will have to pay additional taxes under the AMT method. If you’re doing your taxes yourself, you can use the Interactive Tax Assistant provided by the IRS. If it determines that you might need to also calculate your taxes using the AMT method, you will need to complete Form 6251 to find out.
When you calculate your tax burden using Form 6251, you are not permitted to take many common deductions and credits. In general, people with a high income who take a lot of deductions are more likely to have to pay higher taxes under the AMT plan. While this was originally intended to keep wealthy taxpayers from abusing those credits, the income limits have not risen as fast as inflation, and many more people may end up with higher taxes.
Who is most likely to have to use the AMT method?
While there is no specific income limit above which you will be required to use the AMT method, people with higher than average incomes are more likely to fall under the limits. However, if your income falls under certain limits, you are exempt and will definitely not need to use the AMT method.
For 2011, those limits are:
- $48,450 for single and head of household filers
- $74,450 for married people filing jointly and for qualifying widows or widowers
- $37,225 for married people filing separately.
For 2012, those limits decrease to:
- $33,750 for single and head of household filers
- $45,000 for married people filing jointly and for qualifying widows or widowers
- $22,500 for married people filing separately.
Any income that you have over those amounts may be subject to the special AMT taxes, which we’ll discuss below.
The following factors also raise the likelihood that you will need to use the AMT method:
- Living in a state with a high-income tax
- Multiple children or other dependents
- Deducting investment expenses
- High property taxes, especially on multiple properties
- Second mortgage or HELOC interest being deducted
- Higher than average medical expenses
- Deducting accelerated depreciation
- Deducting net operating losses
How is your tax burden calculated under the AMT method?
A certain portion of your income is exempted when using the AMT method of calculating your tax burden. Any amount of income above those limits is subject to the special tax rules used for the AMT method. These are quite simple: the tax rate is 26% on income between your exemption amount and $175,000 and 28% on income above $175,000. Remember that you will pay whichever amount is higher when calculating your tax burden, using both the regular method and the AMT method. But when determining how much income you’ll use to calculate your tax burden, the AMT removes many deductions from income, which raises the amount you’ll pay by 26% or 28% on. Calculating your tax burden with the AMT method is done by using Form 6251 or using a computer tax calculation program.
More people are subject to AMT rules than ever before
When the AMT was originally enacted, it was intended to affect only the very wealthy. These individuals were exploiting tax loopholes in order to pay as little in taxes as possible. Understandably, people were angry, and Congress created the AMT in 1969 to prevent these individuals from getting out of paying their fair share. The amount of income that is excluded from tax under the AMT method was very high when it was first enacted, but Congress did not include a provision that would have pegged the income exclusions to inflation. Since then, Congress has manually raised the exclusions each year, and the amount has not kept pace with inflation. That means that each year, Congress must specifically pass legislation to prevent the exclusions from going back down to previous levels.
Over time, the exclusion levels have gone down relative to average incomes. Now it is widespread for higher-earning individuals – particularly couples with children who live in states with a high-income tax – to end up with a higher tax burden because of the AMT method. On average, people who have to use the AMT method to calculate their taxes owe about $2,000 more than they would be using the traditional method of income tax calculation.
When the AMT was implemented, no one intended for the Alternative Minimum Tax method of calculating income taxes to become a burden on the middle class. It was created as a response to the very wealthy taking advantage of complicated tax laws to avoid paying so much in income taxes. However, now the AMT affects many more people and can significantly increase your tax bill if you must use it. Talk to a financial professional about whether you may be subject to the AMT and if there are ways to plan ahead to attempt to avoid it.