The Alternative Minimum Tax is hard to figure, causes higher tax bills and hits more Americans each year. Its impact can be lessened or avoided by some taxpayers by lowering their taxable income.
The Alternative Minimum Tax or AMT was created to catch legal tax dodgers and it works by disallowing many common deductions. Keep reading for some ways to avoid or minimize the damage from the AMT.
What is the Alternative Minimum Tax?
The Alternative Minimum Tax was originally introduced by congress in 1969 because they’d noticed 155 people with very high incomes were using so many tax loopholes they weren’t paying any taxes at all. The problem was, when congress wrote the AMT bill to stop the loopholes from being exploited, it wasn’t tied to inflation. The result is that the AMT has gradually affected more and more Americans with modest incomes every year.
Once hit with the tax, there isn’t much that can be done, but there are certain measures taxpayers can take long term to keep from falling under the AMT. These considerations can be complex, which is why, according to the President’s Advisory Panel on Federal Tax Reform, most people who have to pay the tax hire an accountant to prepare their taxes.
The Alternative Minimum Tax: A Growing Problem
The Tax Policy Center reports that in 1970, the AMT affected 20,000 taxpayers, or 0.01% of the population. Over the next 39 years it gradually grew to include 4,000,000 people, or 1.3%. But the next year, in 2010, it jumped to hit a staggering 27 million, or 8.7%. Once congress passed a law to “patch” the AMT to tie it to inflation, these numbers came down some, but even so it’s estimated that by 2020, 1 in 10 Americans will have to pay the AMT.
Further, figuring the Alternative Minimum Tax is complicated. That’s because the AMT forces taxpayers to do their taxes twice — once under the usual system, and a second time to see whether they’re liable for the AMT.
To Make the AMT Easier
To make things easier, the IRS created an online AMT Tax Assistant. The assistant is an interactive questionnaire that can help taxpayers figure whether they’re liable to pay the AMT without having to do their taxes first.
Another way to simplify Alternative Minimum Tax calculations is by using tax prep software. Software like H&R Block Online, TurboTax and TaxACT asks a string of simple questions, then run the answers through a set of hidden calculations to find out whether a user needs to pay the tax.
How the Alternative Minimum Tax Can Hurt You
The AMT has a lower tax rate (28%) than the maximum possible regular tax rate (39.6%). However, since it also eliminates many deductions that most taxpayers make frequent use of, it quite often results in a higher dollar tax amount. The AMT disallows the following deductions:
- The standard deduction. $6,200 of deductions are eliminated for unmarried individuals or people who are married filing separately. $12,400 are erased for people married, filing jointly. $9,400 of deductions are done away with for heads of household.
- Personal exemptions. The AMT erases $3,950 in personal exemptions per person. That means a family of four that has to pay the AMT will end up paying taxes on $15,800 in income that would otherwise be tax free.
- Medical expenses. Under the Alternative Minimum Tax, medical expenses are deductible only if they’re more than 10% of adjusted gross income.
- Many other itemized deductions. Investment expenses, tax advice and bond interest are just a few of the additional deductions disallowed under AMT calculations. Others include deductions for state and local income tax, real estate taxes, personal property taxes and more.
Who Has to Pay the Alternative Minimum Tax?
For the 2014 tax year, people who earn less than the following amounts will be exempt from the AMT:
- Single Taxpayers: $52,800
- Married Filing Jointly: $82,100
- Married Filing Separately: $41,050
- Head of Household: $52,800
How to Avoid the Alternative Minimum Tax
The AMT is tough to avoid. Since it’s tied directly to a person’s income level, the only way of escaping it entirely is by reducing adjusted gross income (AGI). Anyone who decreases their AGI below the $52,800 individual threshold can generally avoid the AMT. Even those who can’t get their income below the AMT threshold can still reduce they amount they have to pay by lowering their taxable income. This can be done in several ways, including:
- Making a deductible IRA contribution.
- Taking a tax loss, such as by selling an investment that has depreciated.
- Holding off on selling profitable investments until a later year.
- Contributing to a 401K or other tax-deferred retirement plan.
- Signing up for a pre-tax medical plan or “cafeteria plan” at work.
- Taking some pay in the form of education. For example, having an employer cut your salary by $2,000, but pay for a $2,000 class.
There are several other ways to lower taxable income for future years. However, these ways depend on the taxpayer’s individual situation, and they can be confusing. This is why 75% of people affected by the AMT hire an accountant. An accountant can suggest ways of handling a person’s finances that will lessen the AMT tax burden. In some cases, they may even be able to help a client avoid it altogether.
The Bottom Line
The Alternative Minimum Tax is a growing problem. It will continue to affect more and more Americans each year. It only hits those above a certain income level and, although it often can’t be entirely avoided, there are ways to minimize the damage. Using tax prep software can make things easier and professional tax help can decrease the tax burden on an individual long term.
- Simple, Fair and Pro-Growth: Proposals to Fix America’s Tax System – Tax Policy Center
- Aggregate AMT Projections and Recent History: Tax Policy Center