The Alternative Minimum Tax (AMT) was initially enacted to prevent wealthy individuals from avoiding tax liability by strategies and investments that were generally out of reach for the average wage earner. However, the AMT was enacted with a set exemption amount that was not indexed for inflation and was not tied to changes in other tax provisions.
The causes the AMT exemption levels to lag far behind inflation and other tax rate adjustments. As a result, AMT liability began to affect middle-income taxpayers, not the super-rich for which it was originally intended. This meant that many taxpayers were required to compute their income tax liability twice: once under the regular method and once again under the AMT method.
Rather than fixing the system properly, Congress embarked on annual ritual of temporary patches. In late 2010, Congress extended a temporary "patch" relating to the AMT that had been put in place in 2008 in an effort to insulate middle-income taxpayer from the AMT. This spared an estimated 21 million taxpayers from having to pay AMT through 2011. Finally, the American Taxpayer Relief Act of 2012 (the "fiscal cliff" legislation) enacted a permanent fix to at least some of the issues bedeviling the AMT provisions.
Determining AMT liability
The AMT provides a formula for computing tax that ignores certain preferential tax treatments and deductions that taxpayers would otherwise be entitled to claim and imposes a tax on this "alternative minimum taxable income."
The AMT is owed in addition to all other tax liability the taxpayer owes. Thus, if the AMT liability is higher than regular tax liability, then the individual will be subject to the AMT: the amount of AMT tax owed is added to the regular tax owed.
An individual's tentative AMT is generally equal to the sum of:
- 26 percent of the first $175,000 of the taxpayer's alternative minimum taxable income (AMTI) ($87,500 for a married taxpayer filing a separate return); and
- 28 percent of the taxpayer's remaining AMTI. AMTI is the individual's regular taxable income recomputed with certain adjustments and increased by certain tax preferences.
Exemption amount now indexed for inflation
A specified amount of AMTI is exempt from AMT. The amount of the exemption varies based on the taxpayer’s filing status and the tax year involved. Beginning in 2013, these exemption amounts will be indexed for inflation — thus avoiding the mismatch between exemption amount, income and inflation that had caused so many problems with the AMT system.
For 2013, the exemption amounts are:
- $80,800 for married taxpayers filing jointly and surviving spouses
- $51,900 for unmarried individuals
- $40,400 for married taxpayers filing separately
For 2014, the exemption amounts are:
- $82,100 for married taxpayers filing jointly and surviving spouses
- $52,800 for unmarried individuals
- $41,050 for married taxpayers filing separately
AMT Exemption Phases Out at Higher Income Levels
In keeping with the Congressional purpose to extract tax from high-income individuals, the AMT exclusion amount is phased out as one's income increases. Although the AMT exemption amounts for individuals were increased and will be indexed, the threshold levels for calculating the exemption phaseout remain unchanged.
Thus, the exemption amount is reduced by 25 percent for each $1 of alternative minimum taxable income (AMTI) in excess of:
- $112,500 in the case of unmarried individuals,
- $150,000 in the case of married individuals filing a joint return and surviving spouses, or
- $75,000 in the case of married individuals filing separate returns.
However, because the calculation of the phaseout amount is affected by the amount of AMTI exempted, an increase in the exemption amount will also increase the maximum amount of AMTI a person can have before the exemption amount is phased out.
The phase-out threshold is also adjusted for inflation beginning in 2013. Thus for 2013, the AMT exemption amount is reduced by 25 percent for each $1 of AMTI in excess of:
- $115,400 for unmarried individuals
- $153,900 for married individuals filing a joint return and surviving spouses
- $76,950 for married individuals, filing separate returns.
For 2014, the AMT exemption amount is reduced by 25 percent for each $1 of AMTI in excess of:
- $117,300 for unmarried individuals
- $156,500 for married individuals filing a joint return and surviving spouses
- $78,250 for married individuals, filing separate returns.
Be aware of AMT preferences and income computation
The most common items (preferences) that can cause you to become subject to the AMT are listed below. These items must be added back to your taxable income in order to compute your AMT:
- all personal exemptions
- the standard deduction, if you claimed it
- certain itemized deductions
- itemized deductions for state and local income taxes, and real estate taxes
- itemized deductions for home equity loan interest (this does not include interest on a loan to buy, build, or improve your home)
- itemized deductions for miscellaneous deductions
- itemized deductions for any portion of medical expenses that exceed 7.5 percent of AGI but not 10 percent of AGI
- deductions you claimed for accelerated depreciation that exceed what you could have claimed under straight-line depreciation (for property put into service in 1999 or later, this item will not apply to depreciable real estate, and it will generally apply only to 3, 5, 7, and 10-year property on which you claimed the ordinary MACRS depreciation)
- differences between gain or loss on the sale of property for AMT purposes and for regular tax purposes; these differences most commonly occur as a result of the different depreciation methods required under AMT, as described above
- changes in income from installment sales, since the installment sale method generally can't be used for AMT purposes
- changes in certain passive activity loss deductions
- deductions relating to oil and gas investments, or drilling or mining operations
- interest on certain private activity bonds that would otherwise be tax-exempt
If you have large amounts of any items in this list, and your adjusted gross income exceeds the exemption amounts discussed below, you (or your accountant) should compute your AMT liability on IRS Form 6251, Alternative Minimum Tax - Individuals, to determine whether you must actually pay any AMT.