Every year more people are becoming aware of the existence of the Alternative Minimum Tax (AMT). Some of this awareness is the result of the media’s focus on it. Unfortunately, though, many people become aware of this tax only because it has shown up on their tax return unexpectedly. Every year more middle-income Americans find themselves caught by the AMT, and it is painful when it catches you.
The AMT is like that kid in school who said he would share his candy with you if you did something for him and then, after you did it, he just laughed as he ran away. In the same way, the AMT reneges on the promise that certain deductions will reduce your taxes. After you sacrifice and plan for all of the tax-reduction strategies available to you and triumphantly get to the line on your tax return that shows your lowered tax liability, the AMT comes in and tells you that your tax is not high enough and takes away some of your deductions to increase your tax. Are you angry yet?
The AMT was first levied in 1970. It was originally designed to target 155 ultra-high-income households that had little to no tax liability because of how they had structured their deductions. The tax has been modified several times over the last four decades, but the income thresholds that trigger the tax have not been indexed for inflation. As a result, millions of not-so-high-income households are now affected by the tax. If it were not for the one-year patches that Congress enacts each year, many millions more would be affected.
Example Spencer is a single man who works on a road crew for a living. He makes $23 per hour, or about $48,000 per year. Even though his income is far from “high,” he is subject to the AMT.
The AMT was originally designed to make wealthy individuals who had found a way to pay no income tax begin to pay their “fair share.” It is a complicated system of taxation that has its own separate formula, independent of the normal income tax calculation.
Many of the itemized deductions allowed in the calculation of regular income tax are eliminated in the AMT calculations. State income taxes, sales tax, and real-estate taxes are not deductible. Interest on loans for boats or RVs, as well as some home equity interest, is not deductible. All miscellaneous itemized deductions subject to the 2% Adjusted Gross Income (AGI) floor are taken away for the AMT as well. The medical-expense limitation is increased to 10% of AGI instead of 7.5%. Income from certain municipal bonds that is not taxed in the regular tax is added back for the AMT. And so it goes down the line. In short, many of the things that taxpayers rely on to reduce their tax liability are omitted in the calculation of the AMT.
If you use the standard deduction you will need to be concerned with the AMT if you are single and have an AGI above $48,450, or if you are married and have an AGI over $74,450 for 2011 (at the time that this book went to print Congress had not yet set the levels for 2012).. If you itemize your deductions, you will be affected by the AMT if your AGI, minus the allowable AMT itemized deductions, is above the previously listed numbers. As you can see, these AGI numbers apply to many who are not exactly “high-income” taxpayers.
If Congress has not acted by December of 2012, the income thresholds for 2012 would actually be $33,750 for single filers and $45,000 for joint filers—an incredible drop in those thresholds. You can see from these numbers that a staggering number of people would be subject to the tax if the yearly “patch” were not applied; those thresholds are getting close to the national poverty levels, depending on the number of children in a household. The AMT is becoming a tax that nearly everyone could be affected by.
The tax is a flat tax of 26% or 28%, depending on your income. If the calculation of the AMT turns out to be higher than the calculation of your regular income tax, you will owe the higher amount. To make matters worse, some tax credits can’t offset the AMT—compounding the difference between the AMT and the regular tax.
If your AGI will subject you to the AMT, you should consider several things in your tax planning. First, ensure that any “tax-free” municipal bond or bond fund that you purchase includes no “special activity” bonds. The interest from those bonds will be included in the AMT calculation—meaning that these “tax-free bonds” will not be tax-free. The investment company you use to buy the bonds can tell you whether the individual bonds, or those held in your bond fund, are AMT-free.
The second thing you should be aware of in your tax planning is that the very deductions you claim when itemizing deductions on Schedule A (such as state taxes) may be what trigger the AMT. Shifting where you claim these deductions, or when you incur the expenses, can affect the amount of AMT you will owe.
Third, be aware of the deductions that are allowed under the AMT. Home mortgage interest and charitable-giving deductions are fully allowed against the AMT. Above-the-line deductions are also allowed and will reduce this tax. Focus on increasing deductions that minimize the AMT and reducing those that don’t, and you may find that you have a better result in the end.
Here are some specific strategies to reduce your AMT:
The AMT is a very complicated tax. It has so many moving parts and variables that it is hard to fully understand even for many tax professionals, much less other people who don’t devote their life’s work to taxes. The thorns are so numerous that I cannot fully list them here. If you are at risk of being significantly affected by the AMT, I highly recommend professional advice.