Tax Returns Understanding the Alternative Minimum Tax (AMT)

In the past, the rich and wealthy could avoid paying most or all of their income taxes by taking advantage of tax loopholes in the tax code. However, in 1969 the federal government came up with the AMT (Alternative Minimum Tax) in order to put a stop to this tax practice. It was another way to calculate the tax liability for all taxpayers to ensure that everyone paid their fair share of taxes. The Alternative Minimum Tax sets a minimum amount that a taxpayer must pay based upon their income.

The AMT no longer applies only to the rich these days and many middle class taxpayers are now subject to this tax. It is important to know whether you are subject to the AMT because, if you are meant to pay such tax and don't do so, you may be faced with the prospect of a heavy fine plus interest on the unpaid taxes.

How Does the AMT Resemble Familiar Tax Requirements?


The AMT is an alternative tax scheme which is unlike the general tax system which may be familiar to most people. Generally you don't take any of the regular tax deductions and tax exemptions, all of which are replaced by a special exemption under the AMT.

What AMT Tax Deductions or Claims Are Allowed?


Under the AMT and unlike the regular method of taking tax deductions, the following claims and tax deductions are not permitted:
  • Claims for tax exemptions for either yourself or for your dependants
  • Use of the standard deduction
  • Use of itemized deductions for local and state income taxes or for taxes for real estate
  • Use of itemized deductions for loan interest on home equity loans, unless the loan was used to buy, build or make improvements to your home
  • Use of itemized deductions for things such as medical expenses or business expenses
  • Exclusion of gains made during the tax year under the ISO (incentive stock option plan) of your employer
Under the AMT system, the above items are called either "preferences" or "adjustments". The thought here is to close the loopholes that rich taxpayers were using to marginalize the amount of tax they had to pay and now make most of it subject to tax but taxing them at a slightly lower rate.

How to Calculate the AMT


The AMT is calculated as follows:
  • First calculate the AMTI (alternative minimum taxable income). You will need to use IRS Form 1040 to first work out your regular taxable income and then add back all the preferences or adjustments listed above.
  • Next deduct the AMT exemption from this amount as per the IRS. The 2010 AMT exemption for 2010 is $72,450 for a married couple filing a joint return and qualifying widows and widowers. The tax exemption is $47,450 for singles and heads of household and $36,225 if you are married and filing separately.
  • Next, apply the special AMT tables or tax rates. The first $175,000 of income is taxed at special 26% AMT tax rate for married couples filing together or $87,500 for married couples filing separately. Income earned over $175,000 is taxed at a 28% rate, called the "tentative minimum tax."
  • Last, compare the amount you would owe in tentative minimum tax and the amount you owe under the regular tax system. If you are required to pay more under the regular tax system, then that is the amount you are required to pay. If however, the tentative minimum tax works out higher than the regular tax due, the difference between the two amounts is your AMT.
The amounts of the exemptions in 2009 were higher because of the ARRA (American Recovery and Re-investment Act), which came into effect to allow millions of American taxpayers to avoid having to pay the AMT in 2009. It can be quite complicated to calculate the AMT but the IRS website provides a tool to calculate the AMT. There are also AMT instructions from the IRS and an AMT worksheet which will help you through the calculation.

Are You Required to Pay the AMT?


Every year an increasing number of people are required to pay the AMT, especially middle class taxpayers. This is due to the fact that the AMT exemptions and tax rates are adjusted for changes in inflation. The AMT scheme assumes that it is possible to live on the same amount today that you could a few years back. If your taxable income rises, you will approach the AMT limits.

If you are subject to the following, you should probably calculate the AMT and determine whether you are required to pay the tax:
  • You have a children or dependents whom you usually claim exemptions for
  • You normally take itemized deductions for interest charged on a home equity loan
  • You receive income from a rental property you own
  • You normally take deductions for state taxes paid in a high income tax rate state
  • You receive interest income from tax exempt "private activity bonds", which are tax exempt bonds that have been issued by a local government or state to pay for special projects beneficial to the public such as building museum, libraries, etc.
About author
Michael Wechsler
Michael M. Wechsler is an experienced attorney, founder of TheLaw.com, A. Research Scholar at Columbia Business School and of-counsel to Kaplan, Williams & Graffeo, LLC. He was also an SVP and chief Internet strategist at Zedge.net and legal consultant at Kroll Ontrack, a leading service e-discovery and computer forensics service provider.

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