Bank Deal: Earn 1.00% APY on an FDIC-insured savings account at Barclays Bank.
Yesterday I noted that Congress has passed a temporary fix for the Alternative Minimum Tax (AMT). This is actually something that’s been weighing pretty heavily on my mind lately so, when a commenter asked about what the AMT is, I thought I’d spend a little time pulling together some details…
For starters, exactly what is the AMT?
According to the IRS:
The tax laws give preferential treatment to certain kinds of income and allow special deductions and credits for certain kinds of expenses. The alternative minimum tax (AMT) attempts to ensure that anyone who benefits from these tax advantages pays at least a minimum amount of tax.
Hmmm… That’s not particularly helpful.
So let’s try this: The AMT is a parallel tax system with rates ranging from 26%-28%. If your liability is higher under the AMT than under “standard” income taxes, then you have to pay the AMT. Given that standard tax rates top out at 35%, this doesn’t sound too bad. Unfortunately, the AMT also disallows many routine deductions, resulting in a potentially large tax liability.
A bit of background
The AMT was first introduced in 1969 in an attempt to stop the richest households from getting off with little or no income tax liability. At the time, it was intended to target just 155 high-income households. Fast forward to today, however, and the AMT is getting fairly widespread attention. Why? Because it’s not indexed to inflation. Thus, an increasing number of “regular” taxpayers are falling prey to it. Last year the number had climbed into the neighborhood of 4 million filers, and this year it was slated to catch more than 20 million more filers if Congress hadn’t patched it.
AMT risk factors
The AMT disallows certain types of deductions them with a lump sum exemption. As an aside, this exemption is what Congress just voted to increase in order to protect millions of middle-class taxpayers from triggering the AMT. Back to the matter at hand… The more of these disallowed deductions that you would otherwise take, the more likely you are to have a higher tax liability under the AMT, and thus the more likely you are to be subject to it.
For example, the AMT throws out deductions for state and local tax, property tax, home-equity loan interest (if the loan isn’t used for home improvements), medical expenses (these are still allowed, but in a more limited fashion), and various other itemized deductions. All of these things are replaced by a lump sum exemption that’s phased out as your income increases — this is actually what Congress just increased to save taxpayers near the cutoff from slipping over the line.
Large numbers of personal exemptions also put you at risk since those aren’t allowed under the AMT (this, combined with a major uptick in income, is why I’m worried – remember, we have four kids). Other risk factors include large long-term capital gains, the exercising of incentive stock options (ISOs), and certain forms of tax-exempt interest (e.g., municipal bonds supporting so-called “private activities” such as building a stadium).
How do you know if you’re subject to the AMT?
Unfortunately, the only way to know for certain whether or not you have to pay the AMT is to calculate your tax liability both ways. If your AMT liability is larger than you standard income tax liability, then you have to pay the AMT. You can calculate your AMT liability using IRS Form 8801. From what I’ve read, it’s especially important to do this calculation if your gross income is over $100k. And if you don’t compute (and pay) the AMT when you should’ve, the IRS almost certainly will. And failing to pay the AMT when it’s due might trigger an IRS audit.
The good news
As they say, every cloud has a silver lining… In the case of the AMT, this silver lining comes in the form of the AMT Credit. As it turns out, some portion of your AMT liability (anywhere from none to all of it) may be eligible for a credit in future years. In short, if you get hit by the AMT this year but not next year, you may be able to use a portion of your AMT credit to reduce next year’s regular income taxes down to your AMT liability.
Here are a few useful articles on the AMT from various corners of the internet:
- How to Become a Millionaire
- How to Get Out of Debt
- The Best Dollars I've Ever Spent
- How Our Estate Plan is Structured
- How We Paid Our Mortgage In Less than 10 Years
- Money Making Ideas
- How to Manage Your Asset Allocation with Multiple Accounts
- Consumption Smoothing - Save While the Saving's Good
- How to Save on Groceries
- How Much Life Insurance Do You Need?
- Eleven Great Books About Money
- Dave Ramsey is Bad at Math (692)
- Dish Network Customer Service SUCKS (534)
- $8,000 Homebuyer Tax Credit (429)
- Pay Off Mortgage Early or Invest? (424)
- How to Claim the First-Time Homebuyer Tax Credit (352)
- Termite Control: Sentricon vs. Termidor (325)
- How Much Should You Pay a Babysitter? (284)
- Ethanol Blended Gas = Lower Mileage? (272)
- Reduced Credit Limits? Share Your Experience (256)
- $15,000 Homebuyer Tax Credit (242)
- Buying Furniture off the Back of a Truck (228)
- Will Mac OS X Lion Kill Quicken 2007? (191)