The Alternative Minimum Tax (AMT) was designed to keep wealthy taxpayers from using loopholes to avoid paying taxes. But because it was not automatically updated for inflation, more middle-class taxpayers were getting hit with the AMT each year. Congress traditionally passed an annual "patch" to address this until, in January 2013, they passed a permanent patch to the AMT.
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Common AMT questions
Thanks to changes made by Congress, each year the AMT exemption amount automatically adjusts with inflation. The AMT exemption is like a standard deduction for calculating the alternative minimum tax.
The 2021 exemption amounts are:
|Married taxpayers filing jointly:||$114,600|
|Married filing separately:||$57,300|
|Head of Household:||$73,600|
In 1969, Congress noticed that 155 people with high incomes were legally using so many deductions and other tax breaks that they were paying absolutely nothing in federal income taxes. Their nonexistent tax bills were an embarrassment.
So Congress instituted the AMT with the aim of making the tax system fairer. But because the AMT was never indexed to inflation—as the regular income tax is—each year, more and more middle-income taxpayers are snared by a tax originally targeted at the rich.
The AMT exemption amounts are now indexed to rise with inflation.
The AMT is a parallel tax system that operates in the shadow of the regular tax, expanding the amount of income that is taxed by adding items that are tax-free and disallowing many deductions under the regular tax system .
- To figure out whether you owe any additional tax under the Alternative Minimum Tax system, you need to fill out Form 6251.
- If the tax calculated on Form 6251 is higher than that calculated on your regular tax return, you have to pay the difference as AMT in addition to the regularly calculated income tax. It can result in you paying hundreds or even thousands of dollars in additional taxes.
The simplest way to see why you are paying the AMT, or how close you came to paying it, is to look at your Form 6251 from last year.
- Compare the Tentative Minimum Tax to your regular tax (Tentative Minimum Tax should be the line above your regular tax) to see how close you were to paying the AMT.
- Look for entries on lines 2 and 3, which adjust your taxable income for AMT purposes. For instance, you have to put various items back into your income, adding such items as your standard deduction, taxes deducted on Schedule A, the bargain element of any incentive stock options you exercised, as well as several investment related items.
One of the best things that can be said about the AMT is that Congress was successful in making it difficult to get around this tax. To avoid the AMT, you need to understand how the AMT differs from the regular tax system.
We'll walk through Form 6251, line by line, looking at how the AMT handles different deductions and expenses. Wherever we see a tax-planning opportunity, we will suggest how to lessen the impact of the AMT.
Line 1: Taxable income: This line is the amount shown on line 11b of your 1040, which is your taxable income.
Adjustable Gross Income (AGI) minus your standard or itemized deductions (some of which are added back in on the following lines) and Qualified Business Income (QBI) is your Taxable Income.
Line 2a: Standard deduction or deductible taxes from Schedule A: In calculating the AMT, you cannot take itemized deductions for state and local income tax, real estate taxes and personal property taxes, even though these are deductible on your regular return.
Suggestion 1: In a year that you have to pay the AMT, don't bother prepaying real estate or fourth-quarter state estimated tax payments in December. You get no benefit from paying these taxes in a year that you are subject to the AMT.
Suggestion 2: Real estate and personal property taxes are not deductible for AMT if they are part of itemized deductions. Taxes deductible on a business schedule (Schedule C), rental schedule (Schedule E), or farm schedule (Schedule F or Form 4835) are allowed for the AMT.
- Perhaps you can qualify for a home office, which would allow you to deduct part of your home real estate tax on Schedule C.
- If you have a farm operation and use your car in your work, you might be able to deduct the personal property tax on the car on Schedule F.
- If you have vacant land on which you are paying real estate taxes, you could turn it into a farm rental and deduct the taxes on Form 4835.
Line 2b: Tax Refund: If you have a taxable state tax refund on your regular tax return, you get to remove it from your income for AMT purposes because you do not receive a corresponding deduction for state taxes under the AMT.
Line 2c: Investment interest: The investment interest deduction may be different for AMT purposes because it depends on whether you have taxable private activity bond interest (see line 12). If you do, you may have an additional deduction for investment interest.
Line 2d: Depletion: You can calculate depletion from mining, oil, gas, timber or other similar activities for regular tax purposes using either the cost or percentage depletion method. For AMT, only the cost method is allowed.
Suggestion: If this line is generating AMT on your tax return, consider electing the cost method of depletion.
Line 2e: Net operating loss: If you claimed a net operating loss deduction on Form 1040, you have to add it back to your income.
Line 2f: Alternative Tax Net Operating Loss deduction: This is the sum of the alternative tax net operating loss (ATNOL) carryovers and carrybacks to the tax year.
Line 2g: Private activity and tax-exempt bond interest: Normally, tax-exempt interest from private activity bonds is not tax-exempt for AMT purposes. A private activity bond is a state or local bond issued to provide funds for private, nongovernmental activities such as building a sports stadium, industrial development, student loan financing, or low-income housing. These bonds are often issued by states, counties or cities and are tax-exempt for regular federal tax, but not for the AMT. If you invest in mutual funds, the 1099 you get will list how much interest you received from private activity bonds. This amount is entered on Line 12 to show the income as taxable for AMT purposes.
Suggestion: If you are subject to the AMT, invest in tax-exempt bonds issued before 2009 that are not private activity bonds. Many mutual fund companies have two listings of state bond funds, one that contains private activity bonds, and one that doesn't. Read the literature carefully.
Line 2h: Section 1202 exclusion: You can exclude from your income some portion of the gain on the sale of qualified small business stock held more than five years. The gain on the sale of this stock is 50 percent excludable for regular tax purposes, but 7 percent of the excluded gain is added back for AMT purposes.
Suggestion: In the year that you sell qualified small business stock, try to eliminate or reduce as many other AMT adjustments as possible to get the maximum gain exclusion on the sale of the stock.
Line 2i: Incentive stock options: This line is another common problem for people affected by the AMT. If you exercise an Incentive Stock Option (ISO) but do not sell the stock in the year of exercise, the transaction is not taxable that year for regular tax purposes.
However, the difference between the exercise price and the fair market value of the stock on the day of the exercise is an adjustment for AMT purposes and appears on Line 15. For many people, this adjustment can be a very large number. Essentially, you are going to be taxed on a hypothetical profit (what you might have made if you sold the stock on the day you bought it.)
You exercise Incentive Stock Options (ISOs) to purchase 100 shares of stock at $3 per share and you decide to hold the stock as a long-term investment. The stock is trading at $33 per share on the day of the exercise. Line 15 on your Form 6251 is $3000 (100 shares x ($33-$3 per share).
Your basis in this stock is now $300 ($3 x 100) for regular tax purposes, but $3,300 ($33 x 100) for AMT purposes. When you later sell the stock, you will have an entry on Line 18, Disposition of Property Difference, to account for the difference in your tax basis for regular and AMT purposes.
Suggestion 1: If you exercise ISOs as in the previous example at $33 and the stock falls before the end of the current year, you can sell the stock and avoid the AMT. If the stock fell to $25 during the year of the exercise, you would be subject to regular tax on only $22 per share ($25-$3) and not be subject to the AMT adjustment at all.
Suggestion 2: When you exercise ISOs, always use tax planning software to forecast the tax consequences. You may need to sell some of the stock in the year of the exercise to pay the tax due.
Line 2j: Estates or trusts: This line contains differences between AMT and regular tax deductions from estates or trusts. Unfortunately, decisions by the administrators of the estate or trust may be beyond your control.
Line 2k: Disposition of property difference: The tax basis in assets that you sold may be different for regular and AMT purposes depending on the depreciation method you chose (see Line 19), or on your incentive stock options (see Line 15).
Line 2l: Post-1986 depreciation: On this line, you enter the depreciation difference for regular and AMT purposes. For AMT purposes, you generally must depreciate (deduct) business assets over a longer period of time than you can for regular tax purposes. This creates a difference between regular tax depreciation and AMT depreciation. This is an entry that does self-correct. By the time the asset is completely written off, you have received the same deduction for both regular and AMT purposes.
Suggestion: If you have an entry on this line, consider electing a slower depreciation method for your business assets, which could eliminate the AMT adjustment.
Line 2m: Passive activities: This line contains the differences between AMT and regular tax deductions for passive activities. This line usually relates to a difference in depreciation methods for rentals, partnerships or S Corporations.
Suggestion: If the adjustment is from a rental property, consider using slower depreciation methods for regular tax purposes to eliminate an entry on this line. If the adjustment is from a partnership or S Corporation, the depreciation methods are selected at the entity level and there is probably nothing you can do.
Line 2n: Loss limitations: You may have AMT or regular tax differences due to passive investments in partnerships or S Corporations. Depending on your percentage of ownership, you may discuss with the management of these investments any items that are generating AMT on your tax return to see if the AMT impact can be lessened in future years.
Line 2o: Circulation expenditures: This line relates to the difference between how newspaper or magazine circulation expenditures are deducted under both tax systems.
Suggestion: If you have an entry on this line, consider making an election under Internal Revenue Code (IRC) section 59(e) to amortize these expenses over three years for regular tax purposes. This will eliminate the entry on this line for AMT purposes.
Line 2p: Long-term contracts: Long-term construction contractors are generally required to use the percentage of completion method of accounting for long-term contract revenue, rather than the completed-contract method. This is a timing difference that will reverse in later years.
Line 2q: Mining costs: Mining exploration and development costs may also generate an AMT adjustment unless you make an IRC section 59(e) election to write-off the costs over 10 years. Making the election eliminates an entry on this line.
Line 2r: Research and experimental costs: This adjustment is related to a timing difference between deducting Research and Experimental Expenditures for regular and AMT purposes. You can eliminate this line entry if you make the IRC section 59(e) election to deduct the costs over 10 years.
Line 2s: Installment sales: Installment sales of inventory items are not allowed for AMT purposes for sales entered into between August 16, 1986 and January 1, 1987. (Almost no one uses this line.)
Line 2t: Intangible drilling costs preference: This line relates to the difference in timing of the deductions for intangible drilling costs. You can make an election under IRC section 59(e) to write off intangible drilling costs over 60 months for regular tax purposes, and eliminate an entry on this line.
Line 3: Other adjustments: This line relates to any other income or deduction items that are affected by AMT differences, such as taxable IRA distributions, self-employed health insurance, IRA deductions and other income-based calculations.
Having thrown so many items back into your income, you now get a small break. Your taxable income for AMT purposes is reduced by the exemption amount shown above at the beginning of this article. This exemption amount phases out as income increases.
Now you calculate the Tentative Minimum Tax (Line 34). You compare this figure to the tax you calculated under the regular tax system on Form 1040.
The difference, if positive, is the Alternative Minimum Tax.
You add the positive difference, if any, to the your regular tax.
If the calculation on Form 6251: Alternative Minimum Tax shows that your Tentative Minimum Tax is less than your regular tax, you don't owe any AMT, but you may still be affected by the AMT in other ways.
Because of the AMT, you may not be receiving all of your tax credits such as the Low-Income Housing or Work Opportunity Credits.
Your Tentative Minimum Tax limits these credits and most other general business credits other than the energy credit, because these credits cannot reduce the tax you pay below the Tentative Minimum Tax.
- If you have any of these credits, usually from a business entity or an investment, you should analyze Line 2 of Form 6251 to see what you can do to reduce your Tentative Minimum Tax and allow more credits.
- Any general business credit not allowed generally may be carried back 2 years and carried forward 20 years.
Credit for paying the AMT
You might get a tax credit for Alternative Minimum Tax paid in a prior year.
This credit, calculated on Form 8801: Credit for Prior Year Minimum Tax calculates how much of the AMT was related to deferral items, which generate credit for future years, as opposed to exclusion items which are not deductible for AMT, and consequently are lost.
Certain items in Line 2 of the Form 6251 are simply not deductible for AMT purposes, such as taxes, home equity mortgage interest and miscellaneous deductions. Those that are considered exclusion items. will not provide a tax credit for AMT.
Other items create timing differences, such as depreciation differences between the two tax systems, and the phantom income from exercising incentive stock options. These items can generate a credit on Form 8801 and reduce your taxes in future years.
Other portions of Line 2 are deferral items. An AMT credit may be generated based on the reversal of the timing difference of these items. For example, AMT depreciation methods may be slower than those for the regular tax, but you will eventually receive the same deduction. To calculate and report your AMT credit you need to fill out Form 8801: Credit for Prior Year Minimum Tax.
There are some things you can do to plan ahead for the Alternative Minimum Tax:
- Use tax-planning software such as TurboTax during the year to minimize your overall tax liability.
- Study Form 6251 each time you prepare your tax return to see how close you are to paying the AMT. Evaluate how close your Tentative Minimum Tax was to your regular tax. For more in depth information on Form 6251, see the Instructions.
- Check last year's return for any general business credits that are being carried forward. If there are some, they may be due to the Tentative Minimum Tax limit.
- If you exercise stock options during the year, see Incentive Stock Options above for guidance on how the timing of the subsequent sale of stock can affect your AMT liability.
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