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What Is The Alternative Minimum Tax & Will It Cost Me Alot?

What Is The Alternative Minimum Tax & Will It Cost Me Alot?

The alternative minimum tax (AMT) was first introduced in 1969 to prevent the wealthy from enjoying so many deductions and income tax credits that they paid little or no income tax. The good news is, most taxpayers won't have to worry about whether they owe AMT because their total income is less than the AMT exempt amount.

This exclusion of most taxpayers is largely due to the Tax Cuts and Jobs Act (TCJA), which came into effect in 2018. According to the Fiscal Policy Center estimates, TCJA has reduced taxpayers' subject to AMT from 5.2 million to approximately 200,000 in 2018. However, the tax provision is expected to phase out in 2025, and by then, the Center for Fiscal Policy expects the number of AMT taxpayers to increase from 200,000 to over 7 million.

However, taxpayers subject to the AMT cannot receive a tax refund or owe more with their tax return. 


How to calculate AMT

The AMT owed is equal to the difference between what you owe according to the AMT formula and what you owe according to standard tax calculations. The Internal Revenue Service uses Form 6251 as the alternative minimum tax calculator.

To calculate the AMT, you must first recalculate your income after removing several exclusions and deductions. For example, under the AMT, it is not possible to deduct income taxes or state and local sales taxes, interest on equity, or miscellaneous deductions, such as employee expenses or tax preparation fees deductions; and you have to add income from private asset bonds which are normally excluded. Also, the total of itemized deductions is limited, depending on your filing status.

Once you recalculate your total income, you reduce it with the AMT exemption, which depends on your filing's status: $72,900 for single taxpayers, $113,400 for couples filing jointly, and $56,700 for married filing separately. However, when your earnings exceed the phaseout status, the exemption will be reduced by 25 cents for every dollar over the limit.


Alternative minimum tax exemptions

Filing Status

AMT Exemptions

Phaseout Begins

Head of Households

$72,900

$518,400

Married Filing Jointly

$113,400

$1,036,800

Married Filing Jointly

$56,700

$518,400

Singles

$72,900

$518,400

 

 

After calculating the residual income after your exemption, you need to calculate the tax due to the AMT formula. For 2020, the first $197,900, or $98,950 if you are married and filing separately, is taxed at 26%, and any income above this limit is taxed at 28%.

Finally, it would be best if you reduce your foreign tax credit. If your AMT tax is higher than it should be under the standard tax formula, you pay the higher AMT amount.


Who pays the alternative minimum tax?

The differences between the way ordinary taxes are calculated and how AMT is calculated affect the types of people most likely to be affected by AMT. While it may sound counterintuitive, the AMT generally does not affect higher-income earners, as its marginal tax rate is already well above the 26% or 28% charged by the AMT.

First, the AMT does not allow personal exemptions, so parents with more kids are more likely to pay the AMT. Second, the tax affects married taxpayers more than single people because the tax brackets are the same, and the exemption for married people is less than double the exemption for single people. Third, AMT affects people living in high-tax states because state and local tax deductions are not allowed.

According to the IRS, you must attach Alternative Minimum Tax Form 6251 to your tax return if any of the conditions are true:

  • Claim the minimum tax credit from the previous year on Form 8801.

  • Claim the personal use portion of the fuel credit for refueling vehicles on Form 8911.

  • Claim the qualified electric vehicle credit using Form 8834.

  • Line 7 is greater than line 10 of Form 6251.

  • You claim the general business credit, on either line 25 on Form 3800 or line 6 on Form 3800 is greater than zero.


Strategies to minimize your AMT Liability

There is a lot you can do to prevent the AMT. The most effective strategy is to check when you receive and confirm your income and deductions.

For instance, when preparing for a large Roth conversion or considering selling an asset that will generate a major capital gain, consider whether that transaction will be subject to AMT.

Alternatively, taxpayers who are subject to AMT one year but are not subjected to AMT the following year should seek to delay qualifying deductible expenses, such as local property taxes and income state tax, to claim deductions instead of losing them.

However, when you have paid the AMT in previous years, and you don't owe this year, you may be eligible for a special tax credit for paying taxes in the past. To apply for the credit, complete Form 8801 with your tax return. However, if you apply for credit, you must attach Alternative Minimum Tax Form 6251 to the statement.


Updates on the AMT

Besides the phase-out amount and the values of exemptions that are increasing for the 2020 tax filing, and the values to which the rates of 26% and 28% apply, there is no other option worth mentioning. The limitation on excess business losses for unincorporated taxpayers has been increased for the 2020 tax year and retrospectively to 2018 and 2019. If you claimed this loss on a 2018 or 2019 tax return, use Form 1040-X to submit an amended income tax return.


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