Alternative Minimum Tax 101
By Kaye A. Thomas
Current as of December 24, 2014
Learn the basics of alternative minimum tax (AMT).
The name of this tax inspires some people to imagine a world where we have a choice (or alternative) to pay a smaller amount (a minimum tax). It is our sad duty to crush that dream. The first thing to understand about the alternative minimum tax (or AMT) is an additional tax some people have to pay, on top of the regular income tax.
Why? The original idea was to prevent people with very high incomes from using special tax benefits to pay little or no tax. The AMT has increased its reach, however, and now applies to many people whose income is higher than average but not extremely high, even when they don’t claim lots of special tax benefits.
We’re stuck with it. Hardly anyone likes the AMT, but proposals to repeal it have languished for years and effective action does not appear to be on the horizon.
So what’s with the name? The name comes from the way the tax works. The AMT provides an alternative set of rules for calculating your income tax. In theory these rules determine the minimum amount of tax that someone with your income should be required to pay. If you’re already paying at least that much because of the regular income tax, you don’t have to pay AMT. But if your regular tax falls below this minimum, you have to make up the difference by paying alternative minimum tax.
Q: How do I know if I have to worry about the AMT?
A: Generally AMT is not an issue for people whose income falls below the level of the AMT exemption amount: in round numbers, $50,000 for singles and $80,000 for couples. (The exact numbers, which are adjusted each year for inflation, are available in our Reference Room.) Above that level, most people rely on tax software to determine whether they owe AMT and if so, how much.
For those who insist on preparing their tax returns by hand (presumably with quill pens), there’s no easy rule of thumb that rules you in or out of AMT. Chances are pretty good that you owe the tax if you have a large itemized deduction for state and local tax, or a large number of dependency exemptions, but various other items (see Top 10 Things that Cause AMT Liability), individually or in combination, can trigger this tax. The only way to be sure, when preparing a return by hand, is to endure the brain damage associated with working through IRS Form 6251.
The best way to understand alternative minimum tax liability is to see how it’s calculated. Here’s an overview.
Compute your tax under an alternative set of rules
First, you figure the amount of tax you would owe under a different set of rules. What’s different about these rules? Broadly speaking, three things:
- Cutback in benefits. Various tax benefits that are available under the regular income tax are reduced or eliminated.
- AMT exemption. You get a special deduction called the AMT exemption, which is designed to prevent the AMT from applying to taxpayers with modest income. This deduction phases out when your income reaches higher levels, a fact that causes significant problems under the alternative minimum tax.
- AMT rates. You calculate the tax using AMT rates, which start at 26% and move to 28% at higher income levels. In the income range where the AMT exemption amount is being phased out, however, the AMT applies at an effective rate of 35%. By comparison, regular income tax rates start at 10% and then move through a series of steps to a high of 39.6%.
The result of this calculation is the amount of income tax you would owe under this “alternative” system of tax.
Compare with the regular income tax
In theory, this alternative tax is the minimum amount someone with your income should have to pay, so the next step is to compare it with your regular income tax. If the regular tax is the same or higher, you don’t owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT you have to pay.
Example 1: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $39,000. That’s lower than the regular tax, so you don’t pay any AMT. You still have to pay the full regular tax of $47,000, though. The minimum tax calculation says you have to pay at least $39,000, but does nothing to reduce your tax if you’re paying more.
Example 2: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $58,000. You have to pay $11,000 of AMT on top of the $47,000 of regular income tax.
If you owe AMT, you should know the following:
- Reporting: To calculate and report your AMT liability you need to fill out IRS Form 6251.
- Estimated tax: You’re required to take your AMT liability into account in determining how much estimated tax you pay. For information about estimated tax payments, see our Guide to Estimated Tax.
Here again it falls to us to banish the fondest hopes of our readers. Yes, there is something called the AMT credit. Who gets to claim it? Hardly anyone, unless they paid AMT because of something called an incentive stock option, which we discuss elsewhere on this website. Even then, it usually doesn’t work out the way people hope, but that’s a story for another day.