Alternative Minimum Tax

The Alternative Minimum Tax is not new; in fact it first appeared on tax forms dating back to 1978. Unfortunately, more individuals are falling victim to the alternative minimum tax, and they don't completely understand its purpose.

Alternative Minimum Tax Rules

The IRS's tax code gives special treatment to certain kinds of income, and allows taxpayers to take tax deductions, or provides credits, for special expenses.  If you qualify for too many of these exemptions or tax credits, then your tax liability may fall below the alternative minimum tax threshold.  When that occurs, the alternative minimum tax applies.  This AMT ensures that taxpayers don't benefit too much from these special provisions, and they are paying their fair share, or a minimum tax.

When a taxpayer qualifies for the alternative minimum tax, they're directed to a special form that calculates their tax liability.  This form uses a different formula than the "standard" tax rate calculation.  Essentially, the taxpayer adds back certain tax deductions they may have taken against their income.  Once they've gone through the alternative minimum tax calculation, they will pay the higher of their "standard" tax liability or the minimum tax.

Purpose of the AMT

The intention of the alternative minimum tax, or AMT, is to set a minimum tax rate of around 27% for some of the highest earning taxpayers in the United States.  The AMT prevents these individuals from taking advantage of tax loopholes, which allow them to shelter a substantial amount of their income from federal income taxes.  The AMT eliminates some of the benefits of what are called "tax preference" items including:

• Accelerated depreciation rates
• Long-term capital gains
• Percentage depletion
• Tax exempt income
• Tax credits

Unless changed by Congress, an estimated one in five taxpayers will have an AMT liability by the tax year 2012.  This problem stems from a lack of indexing for inflation for thresholds, and is widely viewed as a flaw in the alternative minimum tax rule's initial design.  In 2006, an estimated 3.8 million taxpayers were affected by the Alternative Minimum Tax.  By 2007, that number grew to 23 million taxpayers.  That's over a five-fold increase in just one year's time.

Recent Changes to the AMT

For the 2011 tax year, if you made over $75,000, then you should run through IRS form 6251 to make sure you are not subject to the minimum tax.  In addition, if your taxable income for normal tax purposes, plus any adjustments and preference items that apply, are more than the exemption amount, then you may have to pay the alternative minimum tax.

The AMT exemption amounts for the tax years 2010, 2011, and 2012 appear below. Starting in 2012, the lower exemptions amounts will result in more taxpayers being subject to these calculations.

The 2012 AMT exemption amounts include:

• If your filing status is married filing jointly, or are a qualifying widow or widower, then the exemption amount is $45,000.
• If your filing status is single or head of household, then the exemption amount is $33,750.
• If your filing status is married filing separately, then the exemption amount is $22,500.

The 2011 AMT exemption amounts include:

• If your filing status is married filing jointly, or are a qualifying widow or widower, then the exemption amount is $74,450.
• If your filing status is single or head of household, then the exemption amount is $48,450.
• If your filing status is married filing separately, then the exemption amount is $37,225.

The 2010 AMT exemption amounts include:

• If your filing status is married filing jointly, or are a qualifying widow or widower, then the exemption amount is $72,450.
• If your filing status is single or head of household, then the exemption amount is $47,450.
• If your filing status is married filing separately, then the exemption amount is $36,225.

Some of the adjustments and tax preference items include: certain itemized deductions, taxable state and local tax refunds, accelerated depreciation of certain property, certain tax exempt interest and the difference between the alternative minimum tax and a regular tax gain or loss on the sale of property, treatment of incentive stock options, and depletion allowances.

For more complete instructions, see the information contained in IRS Form 6251.

AMT Calculations

In addition to running through your normal, or standard, income tax calculations, the alternative minimum tax uses a second set of rules for determining taxable income as described in IRS publication 6251.  The outcome of those calculations is what's called a Tentative Minimum Tax, or TMT, which is then compared to the income taxes owed using the "standard" method.

If this standard income tax owed is greater than the calculated TMT, then the taxpayer owes income taxes based on the standard method.  However, if the Tentative Minimum Tax is greater than the standard tax calculation, then the difference between the TMT and the standard method is added to the taxpayers "normal" tax liability.  This total amount is the amount of income taxes owed, and referred to as the alternative minimum tax.

Sheltering from the Alternative Minimum Tax

If you are looking to shelter yourself from this tax, then your strategy should be to accelerate your income, and defer deductions you may have taken.  Some of the ways you can accelerate income include:

• Withdrawing money from a taxable IRA or 401k plan
• Cashing in any U.S. Savings bonds, Series EE, that you may be holding
• Taking a short-term capital gain on a stock position you are holding
• Switching from tax-free bond holdings to taxable bonds
• Closing out a certificate of deposit to take the interest income gain

If you are running a business, then you can defer deductions by depreciating capital expenditures such as the purchase of office equipment instead of expensing the cost in the current year.

Finally, you can delay the payment of certain deductible items to reduce the risk of paying the alternative minimum tax.  For example, in December 2012 you may have prepaid real estate taxes that are due in January 2013.  This strategy allows you to take the tax deduction in 2012, which lowers your tax liability, but may trigger a minimum tax.  You can also apply this same strategy to medical expenses and un-reimbursed business expenses.

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