Money Essentials

Understanding the Alternative Minimum Tax (AMT)

Maybe you've managed to ignore the recent spate of tax-reform stories, but that doesn't mean you'll dodge the Alternative Minimum Tax or its higher tax bite.

The AMT system comes with a completely different set of rates and deduction rules. People pay it only if their AMT tax amount is higher than their traditional taxes. Translation: If you're paying the AMT, you are by definition paying higher taxes.

A tale of two systems

Under the regular IRS rules, you start with your gross income and subtract deductions like state taxes you paid, and exemptions like child credits. Eventually, you arrive at your taxable income.

Under AMT rules, you still start with your gross income, but many of the usual deductions and exemptions are disallowed. Suddenly, your taxable income is a lot higher.

Even though some deductions still stand, including those for mortgage-interest and charitable donations, some key breaks are lost. They include: state and local income taxes and property taxes; child-tax credits; and home-equity loan interest.

Even though the highest tax rate under the AMT -- 28% -- is lower than that in the regular tax system -- 39.6% -- AMT victims are paying more because they're paying on a greater amount of taxable income.

Short of moving to a low-tax state like, say, Texas, said Len Burman, co-director of the Tax Policy Center, there's not a lot you can do to avoid AMT's clutches.

Exemptions and phase-outs

In trying to determine tax liability under AMT, you do get to exempt a certain amount of income from your calculations.

The problem is that the exemptions granted under the AMT have not kept pace with inflation -- while the average paycheck has. For instance, in 1982, the exemption for married couples filing jointly was $40,000. Adjusted for inflation, that would be $95,120 today.

Thankfully, under the American Taxpayer Relief Act of 2012, the AMT will now be annually indexed to keep pace with inflation.

For tax year 2012, the exemptions are $78,750 for married couples filing jointly, $50,600 for single and head of household filers, and $39,375 for married people filing separately.

Really high earners may not even get the full exemption since it is phased out above certain income levels.

Who gets burned?

By law, everyone who files taxes is obligated to figure out whether they have to pay AMT, and they are prompted to do so on line 45 of Form 1040.

There, taxpayers are referred to the AMT worksheet. If the taxable income on the worksheet is higher than the taxable income on the 1040, you are subject to AMT and must fill out the special AMT Form 6251.

But the worksheet and Form 6251 can be daunting, and 75% of AMT payers hire a professional to do their returns, according to the President's Advisory Panel on Federal Tax Reform.

"The first time most people hear about the Alternative Minimum Tax is when they get a letter from the IRS saying that they still owe money," said the Tax Policy Center's Burman.

So how do you know if you'll be one of the unlucky?

If your total deductions and exemptions under the normal tax code come close to the AMT exemption, you want to be on the lookout for the AMT, said Tom Ochsenschlager, vice president of taxation with the American Institute of Certified Public Accountants.

The IRS also offers "AMT Assistant," an online tool that helps you determine whether you need to pay the AMT.

Also be on the lookout if your adjusted gross income changes dramatically because of: a lot of itemized deductions; high local and state tax deductions; child exemptions; or a mortgage deduction.

Then it may be time to get some professional help or some good tax software.

take the test
the test
more lessons
More Money Essentials
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
Awesome car options for first-time buyers There are lots of good options for millennials shopping for their first car. These models might not be the most popular, but they're worth considering. More
6 surprising things for sale on Taobao Consumers can buy just about anything and get it shipped to their door from Alibaba's Taobao, China's most popular online shopping platform. More
Most notorious recalls ever It's not just automakers that issue massive recalls. From lawn darts to Pokemon balls, plenty of other consumer products have been deemed dangerous, or worse, deadly. More

Updated 11/23/2011 with SEO tweaks - abell
Updated 7/27/2012 content changes - aross
Updated 7/30/2012 content changes - aross