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Many tax deductions were intended for the middle class so that they can afford a minimum living. However, most of these also benefited the wealthy, so to prevent that, the tax law provides for an alternative minimum tax (AMT) system, first implemented in 1969, that is parallel to the regular tax system. The AMT is calculated based on the alternative minimum tax income (AMTI) that includes all of the income under the regular tax system plus some income that is tax exempt under the regular tax system. There are also restrictions on claiming itemized deductions, accelerated depreciation, exemptions for dependents, and certain other specialized deductions and credits. After calculating the tax liability under the regular tax system and under the AMT system, the taxpayer pays the greater amount.
There is no specific formula to determine if you must pay regular income tax or the AMT, although you probably won't have AMT liability if your income is less than the AMT exemption amount. Hence, the only way to determine AMT liability is to calculate taxable income using standard procedures and then using the AMT procedures on Form 6251, Alternative Minimum Tax for Individuals. The end result of the AMT calculation is a tentative AMT tax from which the regular tax is subtracted. If the result is positive, then this AMT tax is added to the regular tax on Form 1040; if the result is negative, then there is no AMT. If you use Form 1040A, U.S. Individual Income Tax Return, then the AMT liability is figured on the worksheet and included in the line for AMT tax on Form 1040A.
The AMT includes many of the same types of income and deductions as the regular tax system. For instance, private activity bonds issued by state, county, or local governments are excluded in computing taxable income but are included in computing AMTI. Both tax systems allow depreciation, but the depreciation period is generally longer under AMT. Some deductions have a floor which is higher under AMT than under the regular tax system. For instance, the floor for medical expenses under the regular tax system is 7.5%, but 10% under the AMT system.
Furthermore, none of the elements of the AMT are indexed for inflation. Instead, Congress periodically increases the exemption amounts when it starts increasing the tax liability of many more voters.
Form 6251 starts with adjusted gross income, which is the income before deductions for personal and dependency exemptions and itemized deductions or the standard deduction. Because of personal dependency exemptions and the standard deduction are not included in the AMT calculation, they do not have to be subtracted.
AMT tax is generally calculated by first calculating AMTI. There are 2 types of changes that modify AMTI: adjustments and tax preferences. Adjustments can be either positive or negative – positive adjustments are added to AMTI and negative adjustments are subtracted from it. There are 2 types of adjustments: deduction adjustments and income adjustments. A deduction adjustment arises when an allowable deduction is different under the AMT and regular tax system. As can be seen from the following formula, if the regular deduction is greater than the AMT deduction, then the adjustment is positive; otherwise, it is negative. But, if the AMT income is greater than the regular income, then the income adjustment is positive; otherwise, it is negative.
Deduction Adjustment = Regular Deduction – AMT Deduction
Income Adjustment = AMT Income – Regular Income
This accords with the objective of the AMT system — that the taxpayer pays the highest tax. When the AMT deduction is smaller than the regular deduction, then the difference is added to AMTI, which, of course, increases the AMT. If AMT income is greater than regular income, then this positive adjustment is added to AMTI, which also increases the AMT.
The most common results of these adjustments include:
Tax preferences are specified in IRC §57 and are always positive, so they are always add to AMTI. Tax preference items are deductions that may provide extraordinary tax savings under the regular tax system. Some of the more common tax preferences include the interest on private activity bonds, and the difference between accelerated depreciation and straight-line depreciation on both real property and leased personal property.
The definition of private activity bonds as defined by IRC §141 is complex, but generally private activity bonds are issued by states or municipalities where more than 10% of the proceeds are used for private business use. Private activity bond interest is reported in box 9 of Form 1099-INT.
Example: you earned $200,000 for the tax year, which included $40,000 of tax-exempt interest from private activity bonds. Therefore, your total regular income on Form 1040 was $160,000. Although the interest is exempt under the regular tax system, it is not exempt under the AMT system. Therefore, your income adjustment will be equal to $200,000 – $160,000 = $40,000, which must be added to your AMTI.
The time period for deducting many expenses differs under the regular tax and the AMT system. To see how adjustments work, consider the simple case of circulation expenditures. Under the regular tax system, circulation expenditures can be deducted in the same year that they arise; however, under the AMT system, only 1/3 of the circulation expenditures can be deducted per year, so the entire expense can only be deducted over a three-year period.
| Year | Regular Deduction | AMT Deduction | AMT Adjustment |
| 2009 | $60,000 | $20,000 | $40,000 |
| 2010 | $0 | $20,000 | -$20,000 |
| 2011 | $0 | $20,000 | -$20,000 |
Note that the adjustment for deductions is usually positive in the first year, meaning it adds to income, and negative for subsequent years.
The tax basis of property will probably be different under the regular tax system and under the AMT system, most commonly because of differences in depreciation of the property. Therefore, when property is sold or if there is a casualty loss of income producing or business property, then the gain or loss will probably differ under the 2 tax systems. The gain or loss adjustment is calculated similarly to the calculations for deduction and income adjustments:
Gain Adjustment = AMT Gain – Regular Gain
Loss Adjustment = Regular Gain or Loss – AMT Loss
The alternative tax net operating loss deduction (ATNOLD) is the net operating loss as calculated by AMT rules, which will probably be less than the regular net operating loss (NOL) because preferences and adjusted items have to be added to the regular income tax NOL.
ATNOLD = NOL ± Deduction Adjustments – Tax Preferences
The ATNOLD, like the NOL, can be carried back or carried forward to other tax years. If the taxpayer chooses not to carry back the NOL, then that choice must also apply to the ATNOLD. As the NOL and ATNOLD are carried back or forward, their value is diminished until it is used up. Both the NOL and the ATNOLD must be calculated for each tax year under the appropriate tax system, regardless of which system the taxpayer uses for any given year.
Example: For 2011, you had a NOL of $20,000 and an ATNOLD of $10,000. In 2012, under the AMT system, your ATNOLD is zero, but you have no AMT liability for 2012. Nonetheless, your ATNOLD is used up and cannot be carried forward to 2013 or thereafter.
The AMT exemption amount [IRC §55(d)] is $37,225 for married persons filing separately, $48,450 for single persons and heads of households, and $74,450 for married persons filing jointly and qualifying surviving spouses.
There is also a phaseout for the AMT exemption, equal to 25% of the exemption amount for each one dollar of AMTI that exceeds $75,000 for married persons filing separately, $112,500 for single taxpayers and heads of households, and $150,000 for joint filers and qualifying surviving spouses.
Example: You are a single taxpayer who earned $150,000 for 2011. Therefore, your exemption amount is reduced by ($150,000 – $112,500) x .25 = $9,375. So your AMT exemption would be equal to $48,450 – $9,375 = $39,075.
Subtracting the AMT exemption from the AMTI equals taxable AMT income. AMTI is then multiplied by the applicable AMT rates to arrive at the tentative AMT. The AMT rate is 26% on the first $175,000 of AMT income, or $87,500 if married filing separately, and 28% rate for income above that.
However, net capital gains that qualify for the reduced capital gain rates is the same under the regular and AMT tax system.
The only credit that can be applied to the tentative AMT tax on Form 6251 is the AMT foreign tax credit (AMTFTC), so the tentative AMT minus the AMT foreign tax credit is the AMT.
The foreign tax credit cannot offset more than 90% of the minimum tax.
AMT Tax = Tentative AMT – AMT Foreign Tax Credit
The excess of the AMT over the regular tax is the AMT liability which is reported on the alternative minimum tax line on Form 1040. However, the net result is that whichever tax is greater is the tax that you pay.
Example: you calculate your AMT to be $75,000 and your regular tax is $50,000. Therefore, you would subtract your regular tax from your AMT and add $25,000 to the alternative minimum tax line on Form 1040. This, of course, simply adds the difference to your regular tax, yielding the AMT of $75,000. If your AMT was $30,000, then the difference between the AMT and your regular tax of $50,000 would be negative, so you would put zero on the alternative minimum tax line on Form 1040.
Other credits available under the Tax and Credits section of Form 1040, such as the child tax credit and education credits, can be subtracted from the AMT. Total tax liability is then determined by adding the additional taxes, such as the self-employment tax, under the Other Taxes section of the Form 1040.
The tax burden in the United States, as it is in most parts of the world, is placed mostly on working people, and the current incarnation of the alternative minimum tax does not change that. Inheritance remains largely untaxed and investment income is taxed at a much lower rate than working income, even though there is a much larger deadweight loss of taxation on working income than on investment income, and no deadweight loss of taxation on inherited income. That the wealthy pay a far lower tax rate than the working class has recently been evinced by Warren Buffett, one of the richest men in the world, and by Mitt Romney, the man who is most likely to win the Republican nomination for the United States presidency. For instance, Mitt Romney earned $45 million for 2010 and 2011, and paid an average effective tax rate of less than 15%. By contrast, a self-employed worker who earns a mere $13,665 in 2011, would, under the normal tax laws, pay about 14% just in payroll taxes. (Congress has temporarily lowered this rate to 13.3% to stimulate the economy. Nonetheless, it will probably return to 15.3% by 2013.)
The Democrats in Congress are now trying to pass a law, called, appropriately enough, the Buffet Rule, that assesses an effective tax rate of up to 30% on people who earn more than $1 million per year, phasing in gradually to the full 30% for people who earn $2 million or more. Naturally, the Republicans are against this bill, since it is their mission to protect the wealthy from their fair share of the taxes. Whether this bill passes, will depend on how the people vote in the 2012 elections.
If the bill does pass, then it would be an alternative minimum tax that includes all income instead of just working income. The Congressional Research Service estimates that the bill will affect 94,500 taxpayers and the Citizens for Tax Justice estimates that it would bring in an extra $50 billion a year. (See Turning the ‘Buffett Rule’ Into Law - NYTimes.com.) Although this is a pittance compared to the current debt of the United States, it doesn't negate the tax equity argument. No wealthy person should pay an effective tax rate less than the average rate paid by the middle class, especially considering the fact that the marginal utility of money is much higher for poorer people than it is for richer people. Poorer people, often referred to as the 99%, need the money to buy life's necessities, such as food, housing, and health insurance, while the wealthy use their money to create asset bubbles and to influence politicians.
It is time for an AMT that applies to all income, period.