Tom's Tax Tips: Alternative Minimum Tax

How does the Alternative Minimum Tax Work?

The Alternative Minimum Tax (AMT) is a separate, independent tax calculation completed on a separate tax form (#6251).  AMT uses its own set of rates and its own rules for deductions which are generally less generous than the regular tax rules. Because of these separate, complicated rules, the only way to determine if you owe the AMT tax is by filling out the forms (essentially doing the tax calculation a second time).  Thank goodness for professional tax software made available to everyone at an economical cost (and of course qualified professionals who complete your tax return for a fee).

If your gross income is above $75,000 and you have write-offs for personal exemptions, taxes and home-equity loan interest you most likely fall into an AMT tax category.   Ditto if you exercised incentive stock options during the year, or if you own a business, rental properties, partnership interests or S corporation stock. If you earn more than $100,000, AMT calculations are pretty much required.

Alternative Minimum Taxable Income

AMT rules require adding back some tax deductions and income exclusions to your regular taxable income to arrive at your alternative minimum taxable income. Here is where the most everyone making over $75,000 gets hit!

First, add back the personal and dependent-exemption deductions ($3,900 each in 2013).   Then, if you do not itemize, the standard deduction is added back ($12,200 for joint filers in 2013; $6,100 for singles in 2013).  The state, local and foreign income and property tax write-offs, as well as your home equity loan interest, if the loan proceeds are not used for home improvements also get added back.

The AMT also ignores some itemized deductions, such as investment expenses and employee business expenses, and some medical and dental expenses. AMT rules add the interest from some private-tax-exempt activity bonds to income. Finally, AMT rules force you to pay taxes on the “spread” between the market price and the exercise price of incentive stock options granted by your employer. For example, if you exercised an option to buy 1,000 shares of stock for $3 a share and the stock was trading at $15, the spread would be $12 a share, or $12,000. Under the regular rules, you wouldn't pay current taxes on this amount, but under the AMT, it’s considered income.

Alternative Minimum Tax Benefits

AMT rules allow a couple of small benefits you do not receive under the regular tax rules. For example, while you can’t deduct state, local and foreign taxes under AMT rules, you can exclude the refunds, which are considered income under the regular tax rules. And because you’re taxed on the spread on your incentive stock options, your tax basis for the option shares you bought is higher under AMT rules, meaning your future AMT tax bill will be lower when you sell those optioned shares.  This stock basis adjustment, of course, requires good record keeping.

The AMT form has quite a few other rules that are pluses and minuses related to rental properties, partnerships, and other business entities. My intention is to give you a glimpse of the complicated rules so I will limit the rules explanation to the above paragraphs.

Exemption Parameters

Lastly, the AMT exemption is deducted from the recalculated AMT taxable income -- $80,800 for 2013 joint filers; $51,900 for unmarried persons; $40,400 for those who use married filing separate status. However, this exemption is reduced by 25 cents for each dollar of AMT taxable income above the applicable annual threshold. For 2013, the thresholds are $153,900 for married joint-filing couples, $115,400 for singles, and $76,950 for folks who use married filing separate status.  After the exemption (if any) has been deducted, the result is subject to the AMT rates:

1. 26% on the first $179,500 for 2013 or $89,750 for if you are married and file separately from your spouse and
2. 28% on the excess. If the AMT exceeds your regular tax, you have to pay the greater amount. 

Technically, the AMT is shown on your federal income tax return as just the liability over and above the regular tax, and this figure is entered on page 2 of Form 1040.

ALERT:  There may be a recovery of some of the AMT paid.  It’s possible to be eligible for the so-called minimum tax credit, which allows taxpayers to claim a credit on their tax return in future years for some or all of the extra AMT tax you paid.  Another tax form, 8801, is necessary to determine if you are eligible. For whatever reason, the tax rules say that exercising incentive stock options is one of the few things that qualify you for the AMT credit, so if that’s the reason or one of the reasons you paid an AMT tax, make sure this credit calculation form is included in your tax return.