Alternative Minimum Tax 101
By Kaye A. Thomas
Updated January 31, 2008
A brief overview of the alternative minimum tax (AMT).
The alternative minimum tax (or AMT) is an extra tax some people have to pay on top of the regular income tax. The original idea behind this tax was to prevent people with very high incomes from using special tax benefits to pay little or no tax. The AMT has increased its reach, however, and now applies to some people who don't have very high income or who don't claim lots of special tax benefits. Proposals to repeal or reform the AMT have languished in Congress for years, but effective action does not appear to be on the horizon. Until Congress acts, almost anyone is a potential target for this tax.
The name comes from the way the tax works. The AMT provides an alternative set of rules for calculating your income tax. In theory these rules determine minimum amount of tax that someone with your income should be required to pay. If you're already paying at least that much because of the "regular" income tax, you don't have to pay AMT. But if your regular tax falls below this minimum, you have to make up the difference by paying alternative minimum tax.
Q: How do I know if I have to worry about the AMT?
A: Unfortunately, there's no good answer to this common question — which is one of the big problems with the AMT. You can have AMT liability because of one big item on your tax return, or because of a combination of many small items. Some things that can contribute to AMT liability are mundane items that appear on many tax returns, such as a deduction for state income tax or interest on a second mortgage, or even your personal and dependency exemptions. See Top 10 Things that Cause AMT Liability. If you use computer software to prepare your tax return, the program should be able to do the AMT calculation. If you're preparing a return by hand, the only way to know for sure is to fill out Form 6251 — a laborious process.
There are two essential pieces to the AMT. First, you need to understand how your AMT liability is calculated for a year when you pay AMT. And second, you need to know how the AMT credit can reduce your taxes in years after the year you paid alternative minimum tax.
The best way to understand alternative minimum tax liability is to see how it's calculated. Here's the big picture.
Compute an alternate tax
First, you figure the amount of tax you would owe under a different set of rules. What's different about these rules? Broadly speaking, three things:
- Various tax benefits that are available under the regular tax are reduced or eliminated.
- You get a special deduction called the AMT exemption, which is designed to prevent the AMT from applying to taxpayers with modest income. This deduction phases out when your income reaches higher levels, a fact that causes significant problems under the alternative minimum tax.
- You calculate the tax using AMT rates, which start at 26% and move to 28% at higher income levels. By comparison, the regular tax rates start at 10% and then move through a series of steps to a high of 35%.
The result of this calculation is the amount of income tax you would owe under this "alternative" system of tax.
Compare with the regular tax
Then you compare this tax with your regular tax. If the regular tax is higher, you don't owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT you have to pay.
Example 1: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $39,000. That's lower than the regular tax, so you don't pay any AMT.
Example 2: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $58,000. You have to pay $11,000 of AMT on top of the $47,000 of regular income tax.
If you're paying attention, you've probably noticed that the total amount of tax you pay in Example 2 is equal to the tax calculated under the AMT: $58,000. But it's important to note that you actually pay $47,000 of regular tax plus $11,000 of AMT, as we'll see below.
Reporting: To calculate and report your AMT liability you need to fill out Form 6251, Alternative Minimum Tax Individuals.
Estimated tax: You're required to take your AMT liability into account in determining how much estimated tax you pay. For information about estimated tax payments, see Guide to Estimated Tax.
If you paid AMT because of certain "timing items" such as exercising incentive stock options, you may be able to claim a special credit in later years.
details: AMT Credit