For the majority of U.S. taxpayers, the alternative minimum tax (AMT) may never come into play.
Even so, its complex rules have ended up causing worry for people in every tax bracket. Here’s what you need to know about AMT and whether your tax filing could be affected.
What is AMT?
AMT is an additional income tax that is calculated alongside regular income tax. It requires certain taxpayers to determine their liability twice: once using regular income tax rules, and once using AMT rules. They then must pay whichever amount is higher.
Here's how AMT works:
- The taxpayer calculates their regular taxable income.
- The AMT calculation adds back any tax preference items and AMT adjustments to determine alternative minimum taxable income (AMTI).
- After the AMT exemption is subtracted from AMTI, the AMT tax rates are applied to determine tentative minimum tax.
- The taxpayer is subject to AMT if the tentative minimum tax exceeds the regular tax liability calculated on regular taxable income.
Not everyone is subject to AMT. You might be subject to AMT if you earn income above a certain level and/or from certain sources (i.e., tax preference items and /or adjustment items), including:
- Incentive stock options
- Intangible drilling costs
- Tax-exempt interest from certain private activity bonds (PAB)
- Depletion and accelerated depreciation on certain leased personal or real property¹
Why was the alternative minimum tax created?
A simplified version of the AMT, called the add-on minimum tax, was created in 1969 to ensure the country’s wealthiest citizens paid their fair share of taxes. The IRS had discovered that 155 taxpayers with income of more than $200,000 had not paid income tax in 1966 because they used deductions unavailable to the average citizen.² When the public became aware of this, they were outraged. As a result, Congress passed the add-on minimum tax. This add-on tax applied to certain income items that the regular income tax system either taxed lightly or overlooked. The largest of these “preferences” was the portion of capital gains excluded from the regular income tax.
Revisions to the AMT throughout the years increased the number of affected taxpayers from 155 in 1969 to nearly 4.5 million by 2015. Noting that the number of affected people had grown so significantly, changes to the AMT as we know it today were included in the Tax Cuts and Job Act of 2017.
The Tax Cuts and Jobs Act (TCJA) effect
In 2017, the TCJA significantly — albeit temporarily — reduced the impact of AMT and under the new law would only impact 200,000 taxpayers in 2018. The TCJA narrowed the scope of the AMT in at least three important ways:
1. It enacted a higher AMT exemption. For individual taxpayers, it’s $71,700. For married joint filers, it’s $111,700.
2. It raised the income level at which the exemption begins to phase out. For individual taxpayers, phaseout starts at $510,300. For married joint filers it starts at $1,020,600.
3. It eliminated or reduced regular tax deductions that were some of the AMT’s largest preference/adjustment items. Here are some changes made by TCJA that will reduce AMT’s tax preference and adjustment items:
- State and local taxes (SALT) including the real estate tax deduction is limited to $10,000 for regular tax purposes. Previously this deduction was not limited. Since SALT is not deductible for AMT purposes, the maximum adjustment is now only $10,000.
- Miscellaneous itemized deductions. Previously these deductions were allowed for regular tax purposes when they exceeded 2 percent of your adjusted gross income. This deduction has been eliminated for regular tax purposes and thus no longer generates an adjustment item for AMT purposes.
- Personal exemptions. These exemptions are no longer deducted for regular tax purposes and no longer create an adjustment for AMT purposes.
- Home equity loan interest is restricted. Interest on home equity interest loans are no longer deductible for regular tax purposes which eliminates the adjustment for AMT purposes.
The combination of all the regular itemized deduction changes means you would need a significant amount of other tax preferences and adjustment items to trigger AMT.
The AMT exemptions and phase out numbers above are for tax year 2019 and are inflation adjusted annually. These revised AMT provisions, along with nearly all TCJA individual income tax measures, are set to expire at the end of 2025. In other words, unless Congress rules differently between now and then, the AMT exemption and phase outs will return to their much lower pre-2017 levels in 2026. At that point, the AMT will affect approximately 7.1 million taxpayers, and 7.5 million by 2028.³
Could your income trigger the AMT?
Three common scenarios
Many people hoped the TCJA would eliminate the AMT. It didn’t (except for C corporations). However, tax reform and the TCJA changes dramatically reduced the number of taxpayers who would owe AMT at tax time between now and 2025.
Based on the way different factors of the bill interact, it’s hard to predict who will and who won’t have to pay the AMT. According to David Scaife, vice president and wealth planner at U.S. Bank, “The best thing you can do is talk to a financial professional if you’re unsure about your status – and watch for the following common AMT triggers.”
1. You have an income above the AMT exemption. TCJA rules could potentially increase chances of owing AMT for taxpayers who file as:
- Single or head of household and have an adjusted gross income higher than $71,700.
- Married-filing-jointly and have an adjusted gross income higher than $111,700.
“The 2018 TCJA reduced five out of the seven regular tax rates,” says Scaife. “But it held AMT rates at 26 percent and 28 percent. This combination could potentially cause high income taxpayers to end up owing AMT.” Fortunately, he adds, if you’re in that middle-upper income level, you’ll likely end up owing less than you would have prior to TCJA.
2. You exercise incentive stock options (i.e., ISO’s) to buy stock at a discounted strike price. This is not a taxable event for regular tax purposes but is for AMT purposes. If the discount is substantial, a significant adjustment item would exist and increase the potential for the taxpayer to be subject to AMT.
3. You have a high ratio of long-term capital gains to ordinary income. “This scenario wouldn’t affect too many people,” says Scaife. “We’re talking incomes in excess of $1 million combined. It would perhaps be a business owner who sold a business that had grown like wildfire and appreciated steeply over a period of 25-30 years. I’d certainly advise someone in this kind of situation to pay close attention as to whether they might be subject to AMT.” While qualified dividends and long-term capital gains are still taxed at preferential rates of only 15-20 percent, large amounts of such income may cause the phase out of the AMT exemption and indirectly cause the AMT to apply to other income.
Looking to the future
For the most part, Scaife feels the AMT still serves its original function of closing tax loopholes for the wealthiest taxpayers. “At the same time,” he says, “The AMT almost isn’t needed anymore. We already don’t have much in the way of deductions in the parallel system. So in one respect, it’s like we’re all under an AMT system anyway.”
But of course, the 2025 sunset of TCJA will change everything. “At that point, we’ll need the parallel system,” he explains. “The way things stand right now, when 2026 rolls around, we’ll be right back where we were in 2017.”
Because of that known deadline, says Scaife, many people are just holding steady for now. “Everyone knows things will revert back to the way they were before, so it doesn’t make much sense for them to drastically change the way they do things in the meantime.”