Alternative Minimum Tax, or AMT, is an extra tax that requires specific qualifying individuals and corporations to pay on top of regular federal income tax. Originally viewed as a tax for the wealthy population who paid little in income tax, the AMT now affects millions of taxpayers nationwide. With such a large portion of the population at risk of paying these additional taxes, it is important for taxpayers to understand the basics of the AMT, to learn how to complete the form for this tax, and to discover tips on avoiding paying the AMT.
Alternative Minimum Tax
Passed in 1969, the Alternative Minimum Tax (AMT) ensured that taxpayers in the upper-income bracket still paid income taxes. Before the AMT, these taxpayers would use itemized deductions and tax credits to avoid paying income taxes. The AMT is part of the federal income tax system, but is separate from regular taxes and has different tax rates for taxpayers. In the event that you have to pay this tax, the rate for the first $175,000 of AMT income is 26% and 28% for anything over that base amount.
When the AMT was passed in 1969, the income limits were not set for inflation. Although less than 20,000 taxpayers had to pay this tax in the first year (1970), over 2.5 million taxpayers had to pay it a quarter of a century later in 2005. Projections show that in 2010, up to a third of taxpayers will be paying this tax, or approximately 33 million taxpayers. With the portion of the population having to pay this tax increasing each year, it is important to know if you will be subject to paying an AMT.
The basic rules of AMT include income with deductions, stock, ownership, or income. If you have a household income over $75,000 and deductions for personal exemptions or home equity loan interest, you may have to pay an AMT tax. Other reasons for paying the AMT tax include if you have used incentive stock options, own a business or rental properties, or have earned an income greater than $100,000. Separate AMTs exist for individuals owing personal income tax and for corporations owing corporate income tax.
Completing an Alternative Minimum Tax Form
When you fill out your personal income tax return, you need to complete a worksheet to determine if you owe an AMT. If you do have to pay an AMT, you need to complete the Form 6251 from the IRS in order to add back the following deductions and exclusions into your taxable income.
- Your personal and dependent exemption deductions
- Your standard deductions (not itemized)
- State and local taxes
- Home equity loan interest (if the loan was not used for home improvements)
- Miscellaneous itemized deductions and medical expenses
- The spread between the market price and exercise price of incentive stock options received from your employer
Avoiding an Alternative Minimum Tax
Avoiding paying an AMT can be complicated, but by planning ahead for capital gains, deductible expenses, and exercising ISOs, you will be able to reduce the impact of an AMT. You should be cautious for timing your capital gains for either the end of the year or spreading the gains over a number of years through installments. Before liquidating any investment, evaluate your AMT consequences and determine if the sale will have an impact on the AMT.
You should also plan for your payment of state taxes, local taxes, home equity loan interest, medical deductions, and any other itemized deductions to occur in the years you will not face the AMT. These taxes and deductions are not AMT deductible, and will go unused in a year when you pay the AMT. When exercising an ISO, or incentive stock option, you need to check with your tax advisor first. An ISO can result in proceeds causing a significant AMT and an adjustment needs to be reported for AMT purposes.
Although there are ways to avoid the AMT, most people cannot take advantage of this. By paying attention to the eligibility rules of the AMT and keeping in touch with your tax advisor, you may be able to learn of your eligibility early on and be prepared for the additional tax.