Alternative Minimum Tax
Learning Objective
Understand when the alternative minimum tax is applicable and how to compute the tax.
More and more individual taxpayers are subject to two parallel tax calculations, the regular tax and the alternative minimum tax (AMT). The AMT was designed in the 1960s to ensure that wealthy taxpayers could not take advantage of special tax write-offs (“tax preferences” and other adjustments) to avoid paying tax. In general, taxpayers must pay the alternative minimum tax if their AMT liability is larger than their regular tax liability.
The AMT is calculated on Form 6251, using this simplified formula as shown in Table 6.2, “Alternative Minimum Tax Formula”:
Table 6.2. Alternative Minimum Tax Formula
| Regular Taxable Income but before exemptions and standard deduction | |
| + or − | AMT Preferences and Adjustments |
| = | Alternative Minimum Taxable Income (AMTI) |
| − | AMT exemption (phased out as AMTI increases) |
| − | Exemptions-personal and dependents |
| = | Amount Subject to AMT |
| x | AMT Rate |
| = | Tentative Minimum Tax Liability |
| − | Regular Tax |
| = | AMT (if a positive number)[a] |
[a] If the AMT is a positive number, the total tax paid by the taxpayer will be the AMT plus the regular tax. If the AMT is a negative number, the taxpayer owes only the regular tax. | |
The terms “AMT Adjustment Items” and “AMT Preferences” are often used interchangeably, though they have slightly different meanings. In general, adjustments are timing differences that arise because of differences in the regular and AMT tax calculations (e.g., depreciation timing differences), while preferences are special provisions for the regular tax that are not allowed for the AMT (e.g., state income taxes). Both terms refer to items that adjust regular taxable income to arrive at income that is subject to alternative minimum tax. There are over twenty different types of adjustments and preferences used in the calculation of AMT on Form 6251. Some of the common adjustments and preferences are:
The standard deduction is not allowed for AMT.
Personal and dependency exemptions are not allowed for AMT.
For AMT, the medical expenses are limited to 10% of AGI rather than 7.5%.
Deductions for property tax, state income tax, and other taxes are not allowed for AMT.
Only the deduction for home mortgage interest related to the purchase or improvement of a first or second residence is deductible for AMT. The interest deduction on home equity debt of up to $100,000 used for personal purposes is not allowed for AMT.
Miscellaneous deductions are not allowed for AMT.
The regular tax itemized deduction phaseout for high income taxpayers is not required for AMT.
Depreciation is generally calculated over a longer life for AMT, sometimes using a different method.
Net Operating Losses are calculated differently for AMT and often result in an adjustment.
State income tax refunds are not considered income for AMT.
Private activity bond interest is interest from certain municipal bonds not taxed for regular tax purposes, but taxable for AMT.
Other less common AMT differences include the calculations related to incentive stock options, oil and gas depletion, research and development expenses, gains on asset sales such as rental real estate, passive losses, and the gain exclusion for small business stock and other items.
The actual details of the calculation of several of the AMT tax preferences and adjustments are complex and infrequent.
The 2008 AMT exemption amounts and the income level at which the exemption begins to phase out are listed in Table 6.3, “AMT Exemption”.
Table 6.3. AMT Exemption
| Filing Status | AMT Exemption Amount | Phaseout at AMTI of: |
|---|---|---|
| Single | $46,200 | $112,500 |
| Head of household | 46,200 | 112,500 |
| Married filing jointly | 69,950 | 150,000 |
| Married filing separately | 34,975 | 75,000 |
| Qualified widow(er) | 69,950 | 150,000 |
The amount of the exemption is reduced 25 cents for each dollar by which the taxpayer‘s alternative minimum taxable income exceeds the threshold amounts.
Example
Aurora, a single taxpayer, has AMTI of $122,000 in 2008. Her AMT exemption is $43,825, which is calculated as $46,200 − [25% × ($122,000 − $112,500)].
For 2008, the AMT rates for calculating the tentative AMT are 26% of the first $175,000 ($87,500 for married taxpayers filing separately), plus 28% on amounts above $175,000. These rates are applied to the taxpayer’s AMT base from the formula above. The AMT rate for capital gains and dividends is limited to the rate paid for regular tax purposes (e.g., gain or dividends taxed at 15% for regular tax purposes will also be taxed at a 15% AMT rate).
Example
Leo has an AMTI of $270,000, none of which is from capital gains. His tentative AMT tax is $72,100, which is calculated as (26% × $175,000) + (28% × [$270,000 − $175,000]).
The AMT has become controversial in recent years. Many middle class taxpayers now pay AMT because the reduction in tax rates in recent years has not been matched by a reduction in AMT rates. Certain items not allowed as deductions for AMT such as state income and property taxes, miscellaneous itemized deductions, including employee business expenses, and personal and dependency exemptions may cause a taxpayer to owe alternative minimum tax. Projections are that as many as thirty million taxpayers, or roughly 20% of all taxpayers, may be affected by AMT at the end of the decade.
Go to Publication 17 and read Chapter 30: Alternative Minimum Tax.
Questions and Problems
Which of the following is not a tax preference or adjustment item for the individual AMT computation?
Miscellaneous itemized deductions
State income taxes
State income tax refunds
Private activity bond interest
All of the above are adjustments or tax preference items
Pam and Ross are married taxpayers who file a joint tax return. For the current tax year, they have AGI of $80,300. They have excess depreciation on realty of $67,500, which must be added back to arrive at AMTI. The amount of their mortgage interest expense for the year was $25,000, and they made charitable contributions of $7,500. If Pam and Ross’s taxable income for the current year is $40,800, determine the following amounts.
What is the amount of their regular income tax? $__________
What is the amount of their gross AMT? $__________
What amount of tax must they pay? $__________
Aurora and Alex are married and live together in California. During the year, Alex receives a salary of $46,000 and $5,000 of dividends from stock that is his separate property. Aurora receives a salary of $28,000. Aurora and Alex receive $2,500 in interest income from a savings account that was established with community funds.
If Aurora and Alex file separate income tax returns, what amount of income must each report?
Aurora $__________ Alex $__________
If Aurora and Alex live in Louisiana instead of California, what amount of income would each report on a separate income tax return?
Aurora $__________ Alex $__________
Brienna and Carl file a joint tax return in 2008 and have AGI of $179,600. Their itemized deductions totaled $37,200 and included $6,700 in taxes, $11,000 in mortgage interest, and $4,300 in miscellaneous deductions. In 2008, they received an income tax refund check from California of $3,250. They had no other AMT adjustment or preference items. Complete Form 6251 for Brienna and Carl.
The amount of their AMT is: $__________
The amount of their regular tax is: $__________
What is the total tax they will pay? $__________
