Following the discussions about President Trump’s 2005 tax returns on Rachel Maddow’s show last night (more from Forbes’ Dan Alexander on that here), I immediately received questions about the AMT (Alternative Minimum Tax). If you’re scratching your head wondering what the AMT is, exactly, here’s a brief explanation:
The AMT is a secondary tax put in place to prevent the wealthy from artificially reducing their tax bill through the use of tax preference items. The idea was that people who had very high incomes should not be able to use certain deductions to lower their tax bill below what should be reasonably expected for taxpayers at their income level.
The inspiration for the AMT can be traced to 1969 when then Secretary of the Treasury Secretary Joseph W. Barr testified before Congress that 155 individual taxpayers with incomes exceeding $200,000 had paid no federal income tax in 1966. Adjusted for inflation, those numbers from 1966 translate to roughly $1.5 million in today’s money.
How did those taxpayers do it? By exploiting existing tax breaks. High dollar earners generally have high-dollar expenses. They may have more expensive houses, live in high tax areas and spend more money on investments. By maximizing their deductions, and not including certain kinds of income, they were able to decrease their taxable income to practically zero – legally.
As you can imagine, those who were paying taxes were not happy. According to a 2005 report delivered to Congress (downloads as a pdf), following the news, in 1969, members of Congress received more complaints about those 155 taxpayers than about the Vietnam War.
When faced with the question of how to best address the disparity, Congress didn’t tinker with rates, existing deductions or credits. Instead, Congress created the AMT. The AMT is literally a second tax system. With the AMT, you calculate your “normal” tax based on your taxable income, and then you add back in certain tax preference items to calculate the second tax.
That second tax only applies if your income is over a certain amount – remember, the idea is to focus on high-wage earners. But don’t get too excited: that $1.5 million baseline that Secretary Barr testified about? The exemption amount for the AMT has never been that high. For 2017, the numbers start at just $54,300 for single taxpayers:
Income isn’t the sole trigger. AMT only applies if you report certain types of income that receive tax-favorable tax treatment or if you claim certain kinds of deductions. Some of those include:
- Exercising incentive stock options (ISO). Normally, you don’t recognize income when you exercise an ISO but this rule doesn’t apply for the AMT.
- Income or (loss) from tax-shelter farm activities or passive activities.
- Tax-exempt interest from private activity bonds.
- Gain or loss from the disposition of certain kinds of property (for example, a disqualifying disposition of stock acquired in a prior year by exercising an ISO).
- Significant interest paid on a home mortgage not used to buy, build, or substantially improve your home.
- High state & local taxes. If you live in a high-tax state like New York or Hawaii or a municipality with high taxes like Philadelphia or New York City, you can deduct those taxes on your Schedule A if you itemize. For AMT purposes, however, you could lose the deduction.
- High medical expenses. You can itemize these expenses on your Schedule A but the AMT limits this deduction.
- Net operating loss deduction. (More on those here.)
- Intangible drilling, circulation, research, experimental, or mining costs.
- Depletion deduction for mines, wells, and other natural deposits.
There are 60-some lines on the front page of the federal form 6251, Alternative Minimum Tax—Individuals to tackle these tax preference items. If you don’t recognize most, there’s a good reason: they likely don’t apply to you. But you may have to pay the AMT if, after adding back in those adjustments, your income is more than the AMT exemption amount for your filing status.
Wait… there’s more. Your “normal” tax rate doesn’t apply here. For purposes of calculating the AMT, there are two separate tax rates. For the tax year 2016, you’ll pay AMT of 26% if income is $186,300 or less ($93,150 or less if married filing separately) and AMT of 28% if income is more than $186,300.
Confused yet? Fortunately, most taxpayers are not subject to the AMT: those at the very bottom don’t make enough to have to pay it, and those at the top already pay a high tax rate. That leaves those in the middle who might potentially be subject to the tax. Fortunately, however, most people who fill out the AMT form don’t end up paying the tax.
If you’re currently in full-on panic mode because you’ve never filled out an AMT form but wonder whether you probably should have, take a deep breath. Most tax-preparation software and tax professionals automatically plug in those AMT numbers and do the calculations – even if you don’t know about it.
The call for AMT repeal used to be a regular battle cry (that’s why the question has regularly appeared on my “Getting To Know You Tuesday” series). These days, however, there’s less interest. That’s because, for years, the exemption amount had to be manually determined and approved by Congress. Fortunately, on January 2, 2013, as part of the American Taxpayer Relief Act of 2012, those amounts were finally indexed for inflation which means that the exemption amount is now automatically adjusted every year. That index limited the number of taxpayers who would have to pay the tax: without an index, the fear was that tens of millions of taxpayers would be subject to the tax.
For the 2014 tax year, the last year for which complete data is available from the IRS (downloads as a pdf), 4,278,000 taxpayers were subject to the AMT, paying a combined $28.6 billion in tax. The number of taxpayers affected by the AMT represented just under 3% of all taxpayers that year.