Gregory S. DuPont
Have You Been Snagged by the Alternative Minimum Tax?
The alternative minimum tax (AMT), which was created to prevent people with high incomes from avoiding paying little or no tax, has had the unforeseen effect of also netting the “not-so-rich.” Internal Revenue Service (IRS) statistics show that although only 153,265 people paid the AMT in 1979, around 4.3 million did in 2011.
To understand the AMT, think of it as a separate tax system with its own set of rates and rules for deductions that tend to be less generous than the regular IRS rules. As a result, if you have multiple exemptions from dependents and deductions from such areas as interest-paying accounts, second mortgages, capital gains, and state and local taxes, you might be subject to the AMT.
How do you know? The only way to know for sure is to fill out Form 6251. (If you use computer software to prepare your tax return, it may be able to do the AMT calculation.) What you’ll be doing, in effect, is adding back some tax deductions and income exclusions. If your AMT exceeds your regular tax, you have to pay the greater amount. If not, you pay your regular tax.
The American Taxpayer Relief Act of 2012 (ATRA) provided the long-awaited permanent “patch” for the AMT. Over the years, Congress had routinely “patched” the AMT to prevent it from hitting taxpayers with more modest incomes. The ATRA provided a permanent solution to this problem by giving taxpayers higher AMT exemption amounts and other forms of relief starting in 2012, with the amounts adjusted for inflation going forward. The 2015 exemption amounts are increased to $53,600 for unmarried individuals, $83,400 for married taxpayers filing jointly and surviving spouses, and $41,700 for married taxpayers filing separately.
Here’s a general overview of some of the more common differences between AMT rules and ordinary income tax rules that can increase a middle-class taxpayer’s chances of being subject to the AMT:
1. Taxes you paid to your state and local governments are nondeductible for AMT purposes. However, these items are deductible from your regular taxable income. This includes real estate, personal property, and any other tax. Therefore, if you live in New York, Massachusetts, California, or a state with a significant income tax, your chances of being affected by the AMT are increased.
- Mortgage interest you paid and deducted may not be deductible for the AMT, even though it is generally deductible from your regular taxable income. If you obtained a home equity loan that was not used to buy, build, renovate, or improve your home, the interest is nondeductible. Once again, the likelihood that you could be subject to AMT is increased.
- Incentive stock options are often used by employers as part of employee compensation. As an employee, you may have been given a qualifying stock option to purchase your company’s stock in the future. Ordinarily, you would pay no income tax either at the time you receive the stock option or at the time you convert the option to the stock and receive a profit. For ordinary tax purposes, tax is deferred until the stock is sold. However, for AMT purposes, the difference between the fair market value (FMV) of the stock and the amount paid for the stock due to the option is generally considered taxable income when the option is exercised. This may make a big difference for taxpayers with stock options, and can significantly increase their chances of being subject to AMT when they exercise these options.
- Many tax credits and deductions are often not used when calculating the AMT. In addition, the standard deduction is also not considered.
If any of these areas resulted in a substantial reduction of your ordinary income taxes, you should consult with an accountant to check your AMT status. You may be able to take steps now to reduce your exposure and plan ahead for next year’s tax return.