High-income individuals typically pay the Alternative Minimum Tax (AMT). This tax kicks in when taxpayers have an income greater than the annually adjustable exemption amount designed to keep pace with inflation. You must calculate your tax twice if your income exceeds the AMT exemption. First, calculate the regular income tax you owe, then compute the AMT by adding back certain deductions you claim. You then pay the higher tax.
History of the Alternative Minimum Tax (AMT)
The Alternative Minimum Tax (AMT) usually affects married taxpayers with children for several reasons. First, they often have higher income if both parents are working. Second, AMT does not provide additional exemptions for each family member they support.
Congress created a simplified version of the Alternative Minimum Tax in 1969. It was originally known as the “millionaires’ tax.” This was designed after the Internal Revenue Service (IRS) discovered that 155 millionaires paid no taxes in 1969 because they were able to claim large tax deductions that were not available to the average worker. The idea was to ensure that wealthy Americans could not escape taxes by using these loopholes.
The Reagan Administration created a version of AMT to include more widespread exemptions and deductions.
Congress established a higher tax rate on incomes that reached a certain threshold. The AMT added personal exemptions, local and state taxes, and the standard deduction to taxable income. Deductions targeted included union dues and certain healthcare expenses. The Reagan tax reforms eliminated the more complicated investment deductions primarily utilized by the very wealthy.
However, Congress did not adjust income levels to keep pace with inflation at that time, so middle-income families began to find themselves subject to the Alternative Minimum Tax simply because they earned a bit more due to inflation. Congress then passed a “fix” each year to prevent this from occurring.
The American Taxpayer Relief Act automatically adjusted the income thresholds for inflation in 2013.
How the Alternative Minimum Tax (AMT) Works
The AMT differs from the regular tax rate because it does not include the standard deduction or most itemized deductions in its calculations. Some of these itemized deductions include local and state income taxes and business expenses for employees. Property taxes and personal property taxes cannot be deducted under AMT rules.
AMT may include other income streams that are not calculated under regular income tax rules. This may result in the AMT being higher than the regular tax in many cases.
Some other income streams that may be included in AMT calculations include:
- The fair market value of exercised but not sold incentive stock options
- Tax-exempt interest from private activity bonds that have not been sold
- Foreign tax credits
- Passive income and losses
- Net operating loss deductions
As of 2023, there are only two AMT tax rates: 26% and 28%. The 28% AMT rate applied to taxpayers calculating AMT income of $206,100 in 2022. The same rate applies whether you are single for that tax year or filing a joint return. However, married taxpayers filing separately hit this threshold when their AMT income is only $103,050. These thresholds are $220,700 and $110,350 respectively for 2023.
AMT exemptions begin to phase out after reaching a certain income level, but these limits are quite high: $539,900 for single filers and $1,079,800 for married taxpayers filing jointly for 2022, and $578,150 and $1,156,300 respectively for 2023.
How to
AMT Calculation
You should only be concerned with AMT if your adjusted gross income (AGI) exceeds the threshold for your tax status. After that, you must calculate your alternative minimum taxable income and pay the higher tax.
The calculation for AMT that you may owe begins by adding back certain disallowed deductions to your income to arrive at your AMT income. Subtract the AMT exemption for your tax status from this amount. Then multiply the remaining amount by 26% or 28%, depending on your income. You can then subtract any foreign tax credit for the tax year, if applicable.
You can also calculate your AMT income on IRS Form 6251. The form guides you through the steps. Tax preparation software will do all these calculations for you.
Can You Avoid AMT?
You can adjust your spending as you enter a new year to minimize AMT, should your earnings necessitate calculating it and possibly paying it. This may involve how you handle certain tax deductions that must be added back to your income for AMT purposes. Some strategies include:
- Ensure that your state tax withholding isn’t higher than the expected payment, as international tax payments are not deductible under AMT.
- Pay your property taxes only when due. Don’t make the next payment at the end of the year, as that payment will affect that tax year.
- Sell incentive stock options in the same year you exercise them. The value of exercised options becomes income for AMT purposes if you exercise the options and do not sell them.
Frequently Asked Questions (FAQs)
What percentage of income goes to taxes?
Federal taxes have seven tax brackets ranging from 10% to 37%. It is a progressive tax, meaning each higher rate applies as income increases. A 10% tax will be applied to the first $11,000 of your income in 2023 if you are filing single, then any income you have from $11,001 to $44,725 will be taxed at 12%.
How can you reduce the alternative minimum tax?
You should reduce your adjusted gross income to lower AMT through income adjustments that are not tax-restricted. Consider maximizing contributions to a 401(k) or another qualified retirement plan. You can also contribute to a health savings account (HSA) if you have a high-deductible health plan. Consider switching to more tax-efficient investments in taxable investment accounts.
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Sources:
- IRS. “IRS Provides Tax Inflation Adjustments for Tax Year 2023.”
- Tax Policy Center. “What Is the AMT?”
- Tax Policy Center. “What Did the America Taxpayer Relief Act of 2012 Do?”
- Tax Foundation. “2022 Tax Brackets.”
- Tax Foundation. “2023 Tax Brackets.”
- IRS. “Topic No. 556 Alternative Minimum Tax.”
Source: https://www.thebalancemoney.com/alternative-minimum-tax-amt-who-has-to-pay-3305784
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