The alternative minimum tax lives on, but only for a tiny number of taxpayers.
AMT repeal has been on the legislative agenda of both political parties for many years. Years ago, Congress created the alternative minimum tax to prevent high-income taxpayers from reducing their tax bills to levels that seemed unacceptably low, even when claiming legitimate tax benefits. Yet the tax came to be a burden on millions of taxpayers, most of whom were plainly not in the category that prompted Congress to create AMT in the first place.
From time to time we would see AMT repeal proposed as Congress considered a tax overhaul, only to see it dropped from the legislation. A big part of the problem was that the tax generated lots of revenue — over $30 billion in recent years. From the government’s perspective, the AMT was an ATM, and repeal was too expensive.
Until the Tax Cuts and Jobs Act, that is. The huge tax reform law passed at the end of 2017 fell short of full AMT repeal, but gave us the next best thing. It eased certain provisions in the AMT, and also made changes in other parts of the law that have a major effect on this tax. Result: the number of AMT taxpayers will drop an estimated 96%, from about 5,000,000 to 200,000.
How the AMT changed
The law made two changes in the AMT rules, both relating to a special deduction known as the AMT exemption amount. This deduction allows an increment of income to be taxed at 0%, much like the standard deduction under the regular income tax. As of 2018 it’s about 30% larger than it was before.
More importantly, the law vastly increased the income level where this deduction begins to phase out. That’s important because the effective AMT rate in the phase-out range is 35%. Under prior law, this rate would kick in before the regular income tax reached that level, giving many taxpayers an AMT rate higher than their regular rate. For people with income in this range, each additional dollar earned, even from a normal source such as wages, added to the amount of AMT paid.
Other important changes
But that’s not all. AMT applies when the tax calculated under alternative minimum tax rules is greater than the amount you pay under regular income tax rules. The Tax Cuts and Jobs Act changed regular tax rules for two items that previously caused more AMT liability than any others.
One is the deduction for personal exemptions. Before 2018, you could claim this deduction on your regular income tax but not in your AMT calculation. Claiming more personal exemptions made you more likely to pay AMT. Now, the deduction for personal exemptions has been eliminated from the regular income tax as well. Having multiple dependents is no longer a factor in whether you’ll pay AMT.
The other major factor was the itemized deduction for state and local taxes, or SALT. AMT disallows this deduction, so people on a high-SALT diet were more likely to pay this tax. The new law caps this deduction at $10,000 ($5,000 if married filing separately), while also boosting the size of the standard deduction. The combined effect of these changes is that many taxpayers who previously itemized deductions will now claim the standard deduction instead, eliminating the SALT deduction as an AMT adjustment. Many who continue to claim the SALT deduction will find that the $10,000 cap prevents it from throwing them into the AMT.
Who still pays?
AMT repeal isn’t complete. Projections indicate some 200,000 taxpayers will still have to pony up. Most likely they include a number of people who hold tax-favored investments such as real estate or energy partnerships. And many will be people who have made a killing in incentive stock options. Those option holders still need to map a strategy for dealing with AMT if they want to achieve optimal results.
Consider Your Options
Our best-selling guide to strategies for equity compensation, including AMT strategies for incentive stock option holders, is now available in a 2019 edition that reflects the new law.