Most people have never heard of the alternative minimum tax, and those that have probably would love to forget about it and wish that it would just go away.
For 2015, the Tax Policy Center projects the AMT will impact 4.1 million taxpayers and generate $28.2 billion—so it is safe to assume that Congress will not loosen the grip AMT has on taxpayers any time soon. To help ease the painful truth of how AMT can impact your clients, presented below is a brief explanation of what it is and how it is calculated. Sadly, for most of us there is little that can be done to change our AMT liability.
AMT is a tax system that was enacted in 1969 as an add-on tax designed to ensure high-income taxpayers pay at least a minimum amount of federal income tax. It was introduced in response to a Treasury study which reported that, in 1966, 155 wealthy individuals paid no federal income tax. Those high-income individuals were able to side-step income tax by combining enough legal tax breaks and deductions to reduce their tax liability to zero, even though they each reported adjusted gross income of more than $200,000—which is equivalent to $1,254,775 in today's dollars.
What Does the Alternative Minimum Tax Do?
The AMT’s role is to identify taxpayers at higher income levels and prevent them from taking excessive advantage of legal tax benefits that allow them to evade paying their “fair” share of income tax. In 1970, approximately 19,000 taxpayers fell within the AMT’s higher income range and nearly $122 million of AMT was generated. Because the AMT did not have a provision for inflation until the American Taxpayers Relief Act of 2012, the income levels used to target 1970’s “high-income taxpayers” ultimately ended up affecting millions of average income taxpayers who fall under its scope.
Will Your Clients Be Subject to the Alternative Minimum Tax?
Taxpayers only have to worry about the possibility of getting hit with AMT if their adjusted gross income is above a certain income level.
The 2015 income levels for each filing status are as follows:
• Single or head of household - $53,600
• Married, filing jointly - $83,400
• Married, filling separately - $41,700
In general, whether or not a taxpayer is subject to AMT is determined by calculating tax twice. "Regular tax" is first calculated with the regular tax system, and then AMT is calculated with the AMT system. Under the AMT system, an AMT income tax base (AMTI) is computed by taking AGI as computed under the regular tax system and adding back or adjusting certain deductions that are not allowed for AMT purposes. An AMT exemption is then subtracted from AMTI, and the net amount is multiplied by an AMT rate. The resulting AMT is compared to the regular tax and any excess is added to your tax liability as the AMT. Your total tax liability will be regular tax plus AMT.
Alternative Minimum Tax Adjustments
Under the regular tax system, deductions subtracted from AGI will reduce taxable income, thus lowering the amount of tax liability, but for AMT purposes certain deductions are added back.
Below is a (not all inclusive) list of typical deductions allowed under the regular tax system, but not allowed (added back) for AMT purposes:
• State and local income taxes,
• Real estate taxes,
• General sales and personal property taxes,
• Investment advisory fees,
• Personal exemptions,
• Employee business expenses that are itemized on Schedule A, and
• The standard deduction (for non-Schedule A filers).
While the regular tax system allows a deduction for mortgage interest on both acquisition indebtedness and home equity indebtedness, the AMT system allows a deduction only on acquisition indebtedness.
With the AMT system, medical and dental expenses are deductible to the extent that they exceed 10 percent of AGI for all taxpayers. This means the deduction remains unchanged for taxpayers under 65, but is reduced for taxpayers 65 or older.
Whether or not you are subject to AMT, you receive a benefit for making charitable contributions if you itemize since the deduction is allowed under the AMT system.
It is worth mentioning that the preferential rates that apply to qualified dividends and long-term capital gains for regular tax purposes also apply for AMT purposes.
Planning for the Alternative Minimum Tax
Most taxpayers’ goal is to reduce total tax liability, which is the sum of regular tax plus AMT. When a deduction that reduces regular tax liability is added back for AMT purposes, AMT liability will increase.
However, a plan to reduce or eliminate AMT liability by decreasing deductions will, in effect, cause regular tax to increase. Ultimately, what appears to be a viable approach to eliminating the pain of getting hit with the AMT may prove to be nothing more than a pyrrhic victory—AMT will go down, but regular tax will go up.
Overall, there is not much that taxpayers can do to reduce their AMT exposure. Thanks to the AMT, projecting the outcome of strategic tax planning is much more complex than multiplying a marginal tax rate by the change in income or deduction—but it is important to be aware of the AMT, and to consider it in analyzing the impact of any tax-planning strategy.
The Bottom Line
Between 2016 and 2025, the Tax Policy Center projects AMT will generate over $372 billion in revenue, which is possible with the ongoing annual increase in the number of average income taxpayers getting hit with an AMT liability. Chances are at least one of your clients will be subject to AMT. Having a good tax planning strategy in place ahead of time will help them understand what to expect when it is time to file their tax returns. It is more critical than ever for them to enlist the assistance of a tax advisor.
Diana Spatoulas is a senior accountant at Kessler Orlean Silver & Co. PC, in Deerfield, Ill.