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The alternative minimum tax — or AMT, more popularly — has been in the news of late, and while most Americans have heard of it, not many can tell you exactly what the tax is or how it's computed.
Generally, mention of the AMT will create a sense of unease and a glazed look in the eyes.
The origins of the AMT can be traced back to 1969, when 155 taxpayers making over $200,000 had no federal income tax. This situation created outrage and members of Congress received more constituent letters on this matter than the Vietnam War. Congress's solution to the problem was an “add-on” minimum tax that applied to certain items that escaped taxation under the regular tax system.
In 1979, the AMT was enacted and operated alongside the add-on minimum tax. The main aspects of the add-on minimum tax were transitioned to the AMT and in 1983, the add-on minimum tax was repealed.
Currently, there is both an individual AMT and a corporate AMT, and both work the same way: apply a lower tax rate to an expanded tax base. Items that are given preferential tax treatment for regular tax purposes are not allowed for AMT purposes, thereby increasing the overall amount of income subject to taxation. The increased income is taxed at a lower tax rate, and only when AMT is higher than regular tax, will the taxpayer be subject to AMT.
The original AMT affected less than 1 million taxpayers until 2001, when legislation reduced regular tax rates, but left AMT rates unchanged. The spread between the rates was close and it didn't take much in the way of preferential deductions before an individual was in AMT territory.
Individuals have always had an AMT exemption, but the amount was low and not indexed to inflation. The exemption amount was initially set at $30,000 for a single taxpayer and $40,000 for married people filing jointly. This exemption amount was static until 1992 when Congress started making incremental increases. The 2017 individual AMT exemption amount is $54,300 for single filers and $84,500 for joint filers, and the exemption amounts are now indexed for inflation.
As with most tax law, attempts to correct the law have created complexity. The individual AMT rate has two components: the first $187,800 of income above the exemption is taxed at 26% and income above that is taxed at 28%. The exemption also phases out at $129,700 for singles and heads of household, $160,900 for married filing jointly, and $80,450 for married filing separately.
For individuals, the most common tax preferences are:
• Deduction for state and local taxes
• Personal exemptions
• Miscellaneous business expenses
• Standard deduction
For example, John and Jane Doe are New York residents with three dependent children. In 2016, they have $200,000 in salary, $10,350 in state income taxes, $16,000 in real estate taxes, $13,000 of home mortgage interest, and $20,250 of personal exemptions. Regular taxable income is $140,400 and tax on this is $26,643. Of their deductions, state income tax, real estate tax and personal exemptions are tax preference items. These amounts are added back to taxable income for the AMT taxable income. In our situation, AMT taxable income is $187,000 (gross salary less home mortgage interest expense).
The AMT exemption for married filing joint in 2016 was $83,800 but would start to phase-out at an AMT income above $159,700. Because our AMT income is $187,000, the exemption would be reduced by 25% of the amount in excess of $159,700, or $6,825, giving rise to an exemption amount of $76,975. Income subject to AMT is $110,025 ($187,000 - $76,975), taxed at the AMT rate of 26%, giving the taxpayers $28,607 of AMT. The taxpayers will owe $28,607 of AMT instead of $26,643 of regular tax.
This should be a simple tax return — a W-2 with home mortgage interest and taxes, but the tax computation is far from simple. The taxpayer does not own tax shelters, is not taking exotic deductions, yet AMT is due on the return.
Businesses are also subject to AMT. If the business is a flow-through entity, such as an S corporation or a partnership, the tax preferences will be passed-through to the owners of the business. The main tax preference item for businesses is depreciation. AMT requires capital costs to be recovered over a longer life than regular tax, and the difference is a tax preference item.
AMT is on the chopping block for tax reform and we will need to wait to see if it will go away.
Pam Schuneman, C.P.A., is a practicing tax accountant in Sarasota. She has 33 years of experience helping her clients navigate the vast federal tax system and has worked with businesses as varied as Fortune 500 companies to small sole-proprietors. Contact her at [email protected].
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