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An Insight into the Alternative Minimum Tax

An Insight into the Alternative Minimum Tax

Unknown to some people, when they get to a particular income level, a parallel tax system applies to their income. This is a distinct tax structure called the Alternative minimum tax (AMT), which is a surprise to some taxpayers and could be confusing.

For people encountering the alternative minimum tax for the first time, it is essential to get the basics. This article will explore the essentials you should know about AMT and know if you are exempt.

 

What is Alternative Minimum Tax?

Alternative Minimum Tax, as the name suggests, is a unique way of estimating income taxes. It stands out from the general method of calculating such tax. 

For people at some income level, you will calculate your taxes using two approaches. You will likely pay using the AMT approach if it is the higher of the two. However, there are rules for income deductions alongside exemptions that this article will touch upon.

 

History of Alternative Minimum tax (AMT)

The idea behind the alternative minimum tax was to checkmate wealthy taxpayers from employing deductions to dodge income tax. It is a way of ensuring that every taxpayer pays a minimum tax amount. In 2017, there was a change to AMT with the Tax Job and Cuts Act.

TCJA increased AMT exemptions and the threshold for phaseout significantly in 2018. As a result, single filers had their threshold quadrupled from $120,700 to $500,000 in 2018. 

This, alongside other changes made by TCJA, will be in place till 2025, reducing the number of taxpayers subject to AMT. Uncle Sam revealed that there was a heavy drop in the number of taxpayers paying AMT, from above 5 million in 2017 to less than 250,000 in 2018.

 

Estimation of Alternative Minimum Tax 

AMT commences with the regular taxable income. The adjustments and preferences come in, and these calculations either add more income or get rid of some deductions from the ordinary taxable income, which leads to the alternative minimum taxable income (AMTI). Another way to look at AMT is that it leads to some loss of tax breaks. After this, one will subtract the AMT exemption, and the AMT tax rates come in to arrive at the minimum tax.

Here are essential things to do with the AMT tax system:

  • Complete your regular tax return

  • Fill AMT Form 6251

  • Compare both taxes

  • Pay whichever is higher

There is no straightforward way of knowing if the AMT affects you. Although, some factors make you subjected to AMT, as highlighted below:

  • You claimed some itemized deductions from Schedule A

  • You had some incentive stock options that you didn’t sell in the same year

  • There was interest income from some activity bond that was private

In the same way, net operating losses, losses from a passive activity, net operating losses, and other tax items have various AMT calculations.

 

AMT Exemptions

When you add or remove the preference and adjustment, the alternative minimum taxable income remains; and you apply for the AMTI exemption. The exemption amount value is a factor in your AMTI and filing status. For 2021, the exemption amounts are:

  • Married filing jointly or qualified widow(er) — $114,600

  • Single or head of household — $73,600

  • Married filing separately — $57,300

The exemption value is phased out at the rate of 25 cents for every $1 of AMT for income above the following value:

  • Married filing jointly or qualified widow(er) — $1,047,600

  • Single or head of household — $523,600

  • Married filing separately — $523,800

As indicated earlier. Since the exemption and phase-out threshold increases, the AMT does not affect many taxpayers, even when some adjustments bind them.


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