What is the Alternative Minimum Tax (AMT) and How Does It Work?

Alternative Minimum Tax (AMT) is a tax law designed to prevent people from taking too many tax breaks. Learn how it works and if it you owe.
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One of the most confusing things about our tax code is the Alternative Minimum Tax (AMT).

As the name suggests, the AMT is an alternative method of figuring your tax.

In order to determine whether or not you are subject to paying the AMT, you are required to figure out your taxes twice:

  • Once using the “regular” method which most of us are familiar with, and
  • Once using the AMT method which is designed to “catch” those with high incomes who might be underpaying on their taxes.

The Alternative Minimum Tax was originally meant to close loopholes high-income earners were using to avoid paying the taxes they owed, by getting rid of some of the deductions taken by the wealthy.

However, over the years, an increasing number of middle-class taxpayers have been affected by the AMT. As a result, a “patch” is regularly applied so those with middle incomes don’t find themselves hit by the AMT.

What is the Alternative Minimum Tax?

Before we look at how the alternative minimum tax can impact you, let’s explore why it exists in the first place. Understanding the original purpose and reasoning of the alternative minimum tax and how it evolved can help you understand the whole process.

Back in 1969, Congress noticed 155 taxpayers, who were in the high-income range, were not paying taxes because of all of the benefits and deductions.

They knew there was obviously something wrong with the tax system, which led to the creation of the minimum tax, which is the predecessor of the alternative minimum tax.

After about 10 years, the AMT was created because the original tax code did not have the reach Congress intended.

Inside the Alternative Minimum Tax – A Brief Look at How AMT Works

To find out if you are required to pay the AMT, you fill out Form 6251 from the IRS. You also follow the “normal” steps for figuring out your taxes. Then, you compare the outcomes.

  • If it turns out the Alternative Minimum Tax is less than what you owe following the regular rules than you don’t have to pay anything extra. You just pay your taxes as normal.
  • On the other hand, if it turns out your AMT calculation is higher than your normal calculation, you are required to pay the regular tax, PLUS the difference between the two.

So, if you end up owing $35,000 in “regular” tax, but your AMT shows your tax liability should be $40,000, you will need to pay another $5,000 on top of the $35,000, due to the AMT.

Until you actually fill out the tax forms, you really don’t have an idea of whether or not you owe under Alternative Minimum Tax rules. In many cases, having an accountant or tax professional determine your taxes for you can be a big help, since it can be tedious and time-consuming to do your taxes twice.

You should also realize there are some things that actually increase the chances you will owe the AMT. Taking a large amount of personal exemptions and piling on certain deductions, can increase your AMT liability as compared to your “normal” tax liability.

There are deductions that aren’t allowed under the AMT, such as property taxes up to a certain amount, and even the standard deduction and credits. If you are claiming these deductions and credits, and they are disallowed under the AMT, it is possible the difference is great enough to trigger extra taxes for you.

The AMT disallows any state and local tax deductions as well as dependent exemptions. This means certain groups of people are more susceptible to paying the AMT than others.

If you have children and you live in a high-tax state, then you’re much more likely to pay these additional taxes compared to a single person or a family in one of the lower-tax states.

As you consider your taxes for next year, it’s a good idea to consider the tax deductions and credits you claim.

While you want to reduce your tax liability as much as legally possible, it’s also important to consider stretching for certain tax breaks may not be to your advantage, thanks to the Alternative Minimum Tax.

AMT Rates and Limits in 2023

In 2023, the exemption amount for singles is $81,300 and $126,500 for married couples who file jointly.

There are several tax rates you could face if you enter into AMT territory. The highest rate is 28%. There are a lot of different factors and which go into calculating your rates and how much you’ll pay.

Unless you’re a tax expert, or you have access to excellent tax software, then you should use a professional to manage your taxes. We know navigating the various tax forms and exemptions can be a wild ride, and it can have serious consequences if not managed properly.

In most cases, you can find an accounting professional who will complete your taxes for a reasonable fee. It will save you hours of time and frustrating.

Avoiding AMT

If you’ve done the calculations on the Form 6251, and it shows you’re going to owe additional taxes because of the AMT, there is nothing you can do to escape having to pay those additional taxes, but there are some ways you can avoid these additional fees next year.

The best thing you can do to avoid the AMT is to reduce your adjusted gross income. The lower your AGI, the less likely you’ll have to pay the alternative minimum taxes. The easiest and safest way to lower your AGI is to max out your 401k contributions and even maxing out your IRA contributions.

If you’re looking for additional ways to lower your adjusted gross income, consider putting money in a health savings account.

Another quick and simple ways to avoid the AMT is to donate more to charities.

The best way to do this is to have your tax-preparer do the calculations to determine how much you’ll need to donate to avoid the additional taxes. For most people, because they are going to have to pay the money, they would rather give the money to a charity instead of paying it in taxes.

Have questions? Comment below and let’s discuss them.

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