What is the alternative minimum tax and who has to pay it?
Most people never pay the alternative minimum tax, also known as AMT. In fact, according to the Tax Policy Center, in 2019, only 0.1% of households paid the AMT, and the majority of those had income greater than $1 million.
But when the AMT does come into play, it can be an unwelcome surprise that forces you to pay tax on income you thought was tax-exempt or lose out on tax deductions you thought you could claim.
What Is the Alternative Minimum Tax (AMT)?
As the name suggests, the AMT is another way to calculate your federal income tax bill. If you meet certain criteria, you have to calculate your tax liability twice—once using regular income tax rules and again using AMT rules—and pay whichever amount is higher.
The AMT was introduced in 1969 after Treasury Secretary Joseph Barr reported to Congress that 155 wealthy taxpayers with adjusted gross incomes of more than $200,000 (over $1.4 million in today’s dollars) paid no federal income tax at all.
Rather than eliminating tax deductions, credits, and other loopholes in the tax system that made this situation possible, Congress made tax law even more complex by enacting the AMT.
How the Alternative Minimum Tax Works
Calculating the AMT is complicated. For that reason, if you believe you may have to pay AMT, it’s a good idea to use tax software or work with a qualified tax preparer. But here’s an overview of how it works:
- Calculate your taxable income under normal tax rules.
- Complete Form 6251, which walks you through the process of adding back certain deductions and tax-exempt income to determine your alternative minimum taxable income (AMTI).
- Subtract your AMT exemption amount (found on Form 6251) from your AMTI and apply the AMT tax rate to the result to determine your alternative minimum tax.
- If your alternative minimum tax is higher than your regular tax liability, then you have to pay the AMT.
Who Pays AMT
Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), more upper-middle-income households were hit with the AMT. But the TCJA provided higher AMT exemptions and made other changes to the AMT that dramatically reduced its impact.
As a result, according to estimates from the Tax Policy Center, the number of people who pay AMT fell from more than 5 million in 2017 to just 200,000 in 2018, the first year the changes took effect.
If your income is higher than the AMT exemption amount, you must calculate your tax bill under both the regular and AMT rules and pay the higher amount.
However, being a high-income taxpayer isn’t the only thing that can trigger AMT. You might have to calculate your AMT tax bill if you have any of the following:
- Incentive stock options (ISOs)
- Intangible drilling costs (i.e., investing in the oil and gas industry)
- Tax-exempt interest from private activity bonds (PABs)
- Income or losses from passive activities
- The Foreign Tax Credit
- Net operating loss (NOL) deductions
AMT Exemption Amounts
To prevent low- and middle-income taxpayers from getting hit with the AMT, the rules allow taxpayers to exempt some of their income from their alternative minimum taxable income. These exemptions act like a standard deduction for the AMT.
For 2021 and 2022, the AMT exemption amounts are:
|Filing Status||2021 AMT Exemption Amount||2022 AMT Exemption Amount|
|Single and unmarried taxpayers||$73,600||$75,900|
|Married filing jointly and surviving spouses||$114,600||$118,100|
|Married filing separately||$57,300||$59,050|
However, this exemption phases out if you earn too much income. For the 2021 tax year, that phase-out starts at $523,600 of AMTI for single filers and $1,047,200 for married couples filing a joint return. For every dollar of AMTI over that phase-out threshold, you lose 25 cents of your AMT exemption.
For example, say you’re a single filer with AMTI of $600,000. That puts you $76,400 over the phase-out threshold ($600,000 minus $523,600). You have to reduce your AMT exemption amount by $19,100 ($76,400 times 0.25). So only $54,500 of your income would be exempt from AMTI.
How to Determine Alternative Minimum Tax
Use IRS Form 6251 to determine whether you need to pay AMT and how much you’ll owe. Using the 2021 version of Form 6251:
- Line 1. Start with your taxable income using normal IRS rules. You can find this on line 15 of your 2021 Form 6251. If line 15 is zero, subtract the amount on line 14 from line 11 and start with the result.
- Line 2a through 3. Add back certain adjustments that reduced your taxable income under normal tax rules. The list of adjustments is long and includes many income and deduction categories that don’t apply to most taxpayers. You can find more information on each of those items in the IRS Instructions for Form 6251.
- Line 4. Calculate your alternative minimum taxable income by adding up lines 1 through 3. If your filing status is married filing separately and the total is more than $752,800, you need to add an additional amount to the total on line 4. Check the Instructions for Form 6251 to find that additional amount.
- Line 5. Apply the AMT exemption amount based on your filing status and income.
- Line 6. Subtract line 5 from line 4. If the result is more than zero, continue to line 5. If the result is zero or less, enter a zero on lines 6, 7, 9, and ll. You don’t owe AMT.
- Line 7. Apply the AMT tax rate. For most taxpayers, that rate is either 26% or 28%, but a special rate may apply if you claim the foreign earned income exclusion, capital gain distributions, or qualified dividends. Follow the instructions to see whether you need to compute your AMT tax in Part III of Form 6251.
- Line 8. Enter your AMT foreign tax credit, if applicable.
- Line 9. Calculate your tentative minimum tax by subtracting line 8 from line 7.
- Line 10. This line is only for farmers and fishermen who use Schedule J to calculate their tax. If this applies to you, follow the instructions to recalculate the tax here.
- Line 11. Subtract line 10 from line 9. If it’s zero or less, you do not owe AMT. If the result is greater than zero, enter it on line 1 of Schedule 2.
How Does the AMT Affect Tax Credits?
Tax credits reduce the income tax you pay on a dollar-for-dollar basis. For example, if your tax bill is $10,000 and you can claim a $2,000 tax credit, you would only have to pay $8,000 in taxes.
Tax credits such as the child tax credit, the dependent care credit, and the foreign tax credit are a useful way to reduce your AMT liability. You may also qualify for a tax credit if you paid the AMT in prior years.
However, you may lose some of your credits. AMT rules limit business credits, including the Low-Income Housing Credit, the Work Opportunity Tax Credit, and most general business credits. These credits cannot reduce the tax you pay below the tentative minimum tax calculated on Form 6251. If you lose any general business credits due to the AMT, you’re allowed to carry them forward to offset your future tax liability for up to 20 years.
If you have to perform an AMT calculation and compare it to the amount of tax you owe under ordinary income tax rules, it will be complicated to prepare your tax return. For that reason, it’s a good idea to use tax software or work with a qualified tax professional who can help you complete Form 6251.
This will save you a lot of time and aggravation versus trying to calculate your potential AMT liability by hand and help you avoid an IRS notice saying you owe more money.