# Alternative Minimum Tax (AMT) for Individuals

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 taxable income** (**AMTI**) that includes all income taxable 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 a taxpayer must pay regular income tax or the AMT. However, the following common items are not deductible under the AMT system:

- personal exemptions
- state and local taxes
- home equity interest
- interest on loans for boats or RVs
- miscellaneous itemized deductions.

There are some deductions that are still available under the AMT:

- above-the-line deductions
- home mortgage interest,
- charitable deductions,
- business deductions

Therefore, if the taxpayer has substantial deductions under the regular tax system that are not deductible under the AMT system, such as the above items, and if the taxpayer's income, after adding back the disallowed deductions, is greater than the AMT exemption amount, then it is likely that some AMT will be owed.

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 for taxpayers at least 65 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.

A child subject to the kiddie tax who files Form 8615, Tax For Certain Children Who Have Unearned Income may also be liable for the AMT if some income comes from accelerated depreciation, tax-exempt interest from private activity bonds, passive activity losses, certain distributions from estates or trusts, or from other preference items under the AMT tax system. In such cases, the AMT exemption amount may be much lower for the child than it is for other taxpayers. For instance, in 2015, the AMT exemption amount is limited to the lower of the child's earned income + $7400 or $53,600, while the exemption amount for other single taxpayers is $53,600.

## The Rich Do Pay More under the AMT System

On November 2, 2017, the House Republicans presented their tax proposal, containing a provision eliminating the AMT, which has been part of the tax code since 1969. Although the AMT is complicated and there are far easier ways to make the rich pay their share of taxes, the AMT does work. In 2005, Donald J Trump, the current president of the United States, paid $31 million more in taxes because of the AMT. He paid $38 million in federal income taxes on $153 million of reported income. Without the AMT, Donald Trump would have only paid $7 million in taxes, yielding an effective tax rate of 4.6%, a much lower effective tax rate than a single taxpayer with no dependents would pay on income of $15,000.

## Alternative Minimum Taxable Income Formula

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.

- Taxable Income
- + Positive Adjustments
- – Negative Adjustments
- + Tax Preferences

- = Alternative Minimum Taxable Income

### Adjustments

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.

Deduction Adjustment = Regular Deduction – AMT Deduction

Likewise, if the AMT income is greater than the regular income, then the **income adjustment** is positive; otherwise, it is negative.

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:

- No standard deduction and personal exemptions.
- No itemized deductions subject to the 2% AGI floor, such as tax preparation fees and unreimbursed job expenses.
- No home equity interest deduction on a loan used for a purpose other than for buying, building, or substantially improving a primary residence.
- State, local, and foreign taxes are positive adjustments, but a refund of taxes deducted in a prior year are a negative adjustment.
- Medical expenses have an effective 10% AGI floor under the AMT system for all taxpayers.
- MACRS depreciation is calculated under the alternative MACRS system for real estate using a 40-year straight-line recovery and the 150% declining balance method for personal property.
- When
**incentive stock options**(**ISO**) are exercised, a positive AMT adjustment must be made for the fair market value of the stock minus the price paid for the ISO, even if the stock is not sold. If the stock is sold in the same year that the option is exercised, then there is no different tax treatment under the 2 systems, since the taxable income will be equal to the stock sale price minus the option price. **Long-term contracts**, except for home construction contracts, require the use of the**percentage of completion method**rather than the completed contract method for recognizing income.- No tax shelter farm losses are deductible for AMT.
- Passive losses from nonfarming activities are treated differently under the 2 tax systems.
- The deduction for investment interest may be reduced.

However, net capital gains that qualify for the reduced capital gain rates is the same under the regular and AMT tax system.

### Tax Preferences

**Tax preferences** are specified in IRC §57 and are always positive, so they are always added to AMTI. Tax preference items are deductions that may provide large 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 taxable income under the regular tax system 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, which will, of course, bring your income back up to $200,000 under the AMT system.

## How the Regular and AMT System Interact over Time

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 3-year period.

Year | Regular Deduction | AMT Deduction | AMT Adjustment |
---|---|---|---|

2015 | $60,000 | $20,000 | $40,000 |

2016 | $0 | $20,000 | -$20,000 |

2017 | $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.

## Gain or Loss

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

## Alternative Tax Net Operating Loss Deduction (ATNOLD)

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. The result is that the ATNOLD is the excess of allowable AMT deductions over AMTI.

ATNOLD = NOL ± Deduction Adjustments – Tax Preferences

The ATNOLD, like the NOL, can be carried back or 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 they are 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 2015, you had a NOL of $20,000 and an ATNOLD of $10,000. In 2016, under the AMT system, your ATNOLD of $10,000 is carried forward, but you have no AMT liability for 2016, so you cannot use your ATNOLD to offset any income. Nonetheless, your ATNOLD is used up and cannot be carried forward to 2017 or thereafter.

## AMT Exemption

Each taxpayer is entitled to an AMT exemption amount, adjusted for inflation, that reduces the amount of income subject to the AMT. Children who are subject to the kiddie tax also receive an AMT exemption, equal to the lesser of

- the adjustment amount, indexed for inflation, + the child's earned income, or
- the exemption for a single taxpayer.

For instance, the adjustment amount for 2017 was $7,500, so if the child had earnings of $10,000, then her AMT exemption would be $17,500; if her earnings were $100,000, then her AMT exemption would be limited to the AMT exemption for a single taxpayer, which in 2017, was $54,300.

- Exemption and phaseout amounts are, as of 2013, indexed for inflation.
- Exemptions are decreased by $.25 for each dollar of income that exceeds the exemption amount.
- The amount (= AMTI – exemption) subject to the 26% AMT rate is also adjusted for inflation.
- Any amounts over the 26%/28% dividing line are taxed at the 28% AMT rate.

Filing status | Exemption Amount | Phaseout Amount | 26%/28% Dividing Line |
---|---|---|---|

2018: Rev. Proc. 2017-58 | |||

Single, Head of Household | $55,400 | $123,100 | $191,500 |

Married Filing Jointly, Qualifying Surviving Spouse | $86,200 | $164,100 | |

Married Filing Separately | $43,100 | $82,050 | $95,750 |

Estates and Trusts | $24,600 | ||

Children with Preference Items Subject to the Kiddie Tax | Earned Income + $7,650 | ||

2017: Rev. Proc. 2016-55 | |||

Single, Head of Household | $54,300 | $120,700 | $187,800 |

Married Filing Jointly, Qualifying Surviving Spouse | $84,500 | $160,900 | |

Married Filing Separately | $42,250 | $80,450 | $93,900 |

Estates and Trusts | $24,100 | $80,450 | |

Children with Preference Items Subject to the Kiddie Tax | Earned Income + $7,500 | ||

2016 | |||

Single, Head of Household | $53,900 | $119,700 | $186,300 |

Married Filing Jointly, Qualifying Surviving Spouse | $83,800 | $159,700 | |

Married Filing Separately | $41,900 | $79,850 | $93,150 |

Estates and Trusts | $23,900 | $79,850 | $186,300 |

Children with Preference Items Subject to the Kiddie Tax | Earned Income + $7400 | ||

2015 | |||

Single, Head of Household | $53,600 | $119,200 | $185,400 |

Married Filing Jointly, Qualifying Surviving Spouse | $83,400 | $158,900 | |

Married Filing Separately | $41,700 | $79,450 | $92,700 |

Estates and Trusts | $23,800 | $185,400 | |

Children with Preference Items Subject to the Kiddie Tax | Earned Income + $7400 | ||

2014 | |||

Single, Head of Household | $52,800 | $117,300 | $182,500 |

Married Filing Jointly, Qualifying Surviving Spouse | $82,100 | $156,500 | |

Married Filing Separately | $41,050 | $78,250 | $91,250 |

**Example:** You are a single taxpayer who earned $150,000 for 2014. Therefore, your exemption amount is reduced by ($150,000 – $117,300) × .25 = $8,175. So your AMT exemption would be equal to $52,800 – $8,175 = $44,625.

Under the new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act, new provisions, starting in 2018, eliminate the corporate alternative minimum tax and raises the exemption for individuals: $70,300 for singles and $109,400 for joint filers. The phaseout threshold also increases to $500,000 for singles and $1 million for joint filers. Except for the elimination of the corporate AMT, these provisions expire after 2025.

## Calculating AMT from AMTI

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 AMT income not exceeding the 26%/28% dividing line (26% limit), and 28% for income above that.

- Alternative Minimum Tax Base = AMTI - AMT Exemption
- If AMT Base > 26% Limit, then:
- Tentative AMT = (AMT Base – 26% Limit) × .28 + 26% Limit × .26
- Note: Because there is only a 2% difference between the upper and lower AMT base, Form 6251 simply figures the tentative AMT by multiplying the entire amount by .28, and subtracting 26% Limit × .02 from the result. Tentative AMT = (AMT Base) × .28 – 26% Limit × .02

- Tentative AMT = (AMT Base – 26% Limit) × .28 + 26% Limit × .26
- Else:
- Tentative AMT = AMT Base × .26

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.

## Summary AMT Calculation

- Adjusted Gross Income (Line 38 on Form 1040)
- ± Adjustments
- + Tax Preferences

- = Alternative Minimum Taxable Income
- – AMT Exemption

- = Alternative Minimum Tax Base
- × AMT Rate

- = Tentative AMT
- – AMT Foreign Tax Credit

- = AMT
- Payable Tax = Greater of Regular Tax (1) or AMT (5)

## The AMT is more of a Burden for the Upper-Middle-Income Class than it is for the Wealthy Because it Mainly Targets Working Income

The tax burden in the United States, as it is in most parts of the world, is placed mostly on working people, and the AMT system does not change that. It is a needlessly complicated system that does not achieve its objective, because it mostly increases taxes on working income. 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 2012 Republican nominee 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 with no dependents who earns a mere $20,000, would pay more than 18% of his income in taxes.

Even on working income, the AMT does not increase taxes for people with extremely high incomes, because there are already phaseout rules for deductions and exemptions and lowering income with losses from investments is limited by passive activity and at-risk rules. Furthermore, the 3 top marginal tax brackets — 33%, 35% and 39.6% — are higher than the top 28% AMT rate, so the marginal tax rate is actually higher for people earning more than the 33% bracket amount (2015: $189,300).

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 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. The AMT system does not rectify this inequitable tax treatment, while at the same time, making the tax system unjustifiably complex.

A more equitable tax, and one that would be much simpler to calculate, is to impose a graduated marginal tax on all income — not just working income, or what the tax code refers to as **earned income**! Employment taxes, a major burden on poor people, should also be eliminated. Social Security and Medicare can be paid out of the taxes collected from the marginal tax, as it is done in most of the world. After all, there is no reason why employment taxes should just apply to employment! And with a graduated marginal tax on all income, there would be no need for a separate AMT tax system.