I really strive to explain complex topics in a straightforward way. But the AMT is a toughie.
Our “main” tax code is complicated enough. But there is actually a second set of tax rules: the Alternative Minimum Tax rules.
What is the AMT?
The Alternative Minimum Tax (AMT) is a parallel tax system that does not allow many of the deductions, exemptions and credits that many taxpayers use to reduce their tax bills under the regular rules. As a result, more income may be taxed under the AMT.
Although more income is taxed under the AMT, it may be at a lower rate than under the “regular” tax system. The top AMT rate is 28%.
Anyone subject to AMT must calculate their taxes under both sets of rules and pay the higher of the two. The law was created in 1969 to prevent high income earners from completely eliminating tax liability using deductions.
The AMT Exemption and Tax Rates
The AMT exemption is basically a standard deduction for taxpayers hit by the alternative minimum tax.
For 2012, the AMT exemption amounts are:
- $50,600 for single and head of household filers,
- $78,750 for married people filing jointly and for qualifying widows or widowers, and
- $39,375 for married people filing separately.
The exemption amounts mean that this amount of AMT taxable income is not subject to the AMT. Income over these amounts may be subject to AMT. Unlike the ordinary tax rates, the AMT has only two tax brackets of 26% and 28%. The AMT tax rate is assessed only on AMT income over the exemption amount.
Who Pays the Alternative Minimum Tax?
Several factors determine whether you will be subject to the AMT, including income, itemized deductions and personal exemptions. People likely to pay the AMT include:
- High Income Earners. Households in the $150,000 to 415,000 income range are likely to pay the AMT.
- Residents of high-tax states. Deductions for real estate taxes and state and local income taxes aren’t allowed under the AMT. As a result, residents of high-tax states like New York, New Jersey and California are more likely to pay the AMT than residents of low-tax states. (Lucky us!)
- Incentive Stock Option (ISO) exercisers. The AMT treats the difference between the exercise price and the market value on the day of the exercise as a taxable event. This paper profit is not taxable under regular tax rules.
What’s New: No More Patch
As part of the fiscal cliff negotiations, Congress boosted the AMT exemption for 2012 and agreed to index future exemption levels to inflation. (The exemption was not tied to inflation in the past, which led to a last-minute annual “patch” to increase it every year.)
I think this is great news – the rules are still complex, but at least they don’t change every year.
Can I Avoid the AMT?
The short answer is no.
However, it may be time to consider additional tax planning. It may be possible to group income or deductions to help you avoid the AMT in a specific year. Although tax software will compute the AMT for you, you may want to consult a tax professional for advice for your situation.
Please note, changes in tax laws may occur at any time and could have substantial impact upon each person’s situation. You should discuss tax or legal matters with the appropriate professional.
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.