Problems with the Alternative Minimum Tax

The Alternative Minimum Tax (AMT) is a second tax system that operates alongside the standard income tax system. It applies to people whose income exceeds a certain level and is intended to close the loopholes that allow them to reduce or eliminate their tax payments. The AMT was designed to prevent people from avoiding their tax liability under the regular tax rules.

The AMT has its own set of rates (26 percent and 28 percent) and requires a separate calculation from regular federal income tax. Basically, it’s the difference between your regular tax bill and your AMT bill, determined by completing IRS Form 6251: Alternative Minimum Tax – Individuals.

The tax filer will calculate their tax liability as they would normally, then calculate their liability again by applying the AMT rules. When there’s a difference, you may have to pay the AMT amount in addition to your regular tax.

Why Does the AMT Exist?

In 1969, Congress noticed that 155 people with high incomes could take so many deductions and tax breaks that they paid nothing in federal income taxes. Their missing contributions to the American tax collection were an embarrassment.

So, Congress enacted the AMT, intending to make the tax system fairer. However, because the AMT was not indexed to inflation each year, as the regular income tax is, more and more taxpayers who weren’t originally targeted were trapped by a tax that was supposed to focus solely on the rich.

(Note: The AMT exemption amounts are now indexed to rise with inflation.)

How Does the AMT Work?

The AMT increases the income tax for high earners by including income items not taxed on the standard tax rates and reduces many common tax breaks used by individual taxpayers to lower their tax bills.

To be required to pay the AMT, you must have earned more than the following minimums:

The IRS has set income levels to determine which rate you’re charged for your AMT. If your income is below the stated level, you’re taxed at 26 percent. If your income exceeds the stated level, you’re taxed 28 percent on the excess income.

This means that for a single person who earned more than $75,900 in 2022 but less than $206,100, the AMT rate is 26 percent. If that person earned over $206,100, the AMT tax rate goes up to 28 percent.

What are the Arguments in Favor of the AMT?

Those favoring the AMT argue it creates a fairer income tax system. Before the AMT, higher-earning taxpayers who previously claimed considerable deductions and credits would pay little or no income tax. These same tax filers will likely end up paying under the AMT rules.

What are the Arguments Against the AMT?

Those opposed to the AMT argue that the AMT has created inequalities rather than creating a fairer tax system. Critics conclude that the AMT needs to be repealed because it has impacted millions of unintended tax filers. For example, the AMT affects middle-class taxpayers and retirees, people it was not intended to apply to.

Another complaint about AMT is that it affects people differently depending on where they live. If you file taxes in a state with a high-income tax rate, you are more likely to be subject to the AMT than in a state with a lower-income tax rate.

Because of the AMT, tax filers can no longer claim deductions on the state and local level when calculating their AMT.

In calculating the AMT, you cannot take itemized deductions for state and local income taxes, real estate and personal property taxes, and more, even though these are deductible on your regular return. When calculating the AMT:

• You do not receive the standard deduction or personal exemptions
• You cannot deduct state and local taxes
• Medical expenses must exceed 7.5 percent of your gross income to be deducted
• Deductions for home equity loan interest are restricted. It can only be deducted if the money is used solely to pay for home improvements
• Real estate property taxes are disallowed as deductions under the AMT
• Net operating losses cannot be taken as a deduction
• Some tax credits that reduce your regular tax liability do not reduce what you owe under the AMT

Additional tax breaks not allowed under the AMT that affect predominantly high-income people are:

• Incentive stock options
• Intangible drilling costs
• Tax-exempt interest from certain private activity bonds
• Depletion and accelerated depreciation on certain leased personal or real property

Once you add back these disallowed items and run the numbers, you might be subject to a bigger IRS bill if your taxable income exceeds your filing status’s annual AMT exemption amount.

What is the Current Status of the Alternative Minimum Tax?

While the AMT still exists, it has lost some power in recent years. In December 2017, Congress passed the Tax Cuts and Jobs Cut Act (TCJCA). The TCJCA increases the AMT income exemption, increases the exemption phase-out income levels, and eliminates the trigger for middle-class taxpayers to pay the AMT. The IRS estimates that the AMT filings will decrease from 10 million to 1 million because fewer tax filers will have AMT liability. Those who do face AMT liability will pay a reduced amount.

The TCJCA was enacted to simplify the individual income tax. It has reformed the individual income tax by changing the itemized deductions and the alternative minimum tax. It increased the standard deduction, making it much less likely that individuals will try to itemize their deductions. This saves the taxpayer a good deal of time.

The TCJCA implemented permanent indexes for inflation on the exemption amounts, which addressed concerns that the AMT would again apply to unintended filers like the middle class and those on fixed incomes.

The TCJCA also reduced the time to complete the form necessary for documenting your alternative minimum tax information.

Should I Consult an Attorney for Issues with the Alternative Minimum Tax?

Despite Congress’ efforts to simplify the AMT by passing the TCJCA, determining how much alternative minimum tax you must pay is complicated. The Tax Cuts and Jobs Cut Act is still relatively new, making it even more difficult to determine your tax liability.

Some tax professionals can assist you with determining your ultimate tax liability so that you don’t pay too much or too little tax, nor do you run afoul of the Internal Revenue Service. Consult with a professional tax preparer or a tax attorney to fully understand your tax liabilities.