Alternative Minimum Tax (AMT) for Individuals

2024-11-14Many tax deductions were intended for the middle class so they can afford a minimum living. However, most of these also benefited the wealthy. Indeed, during the 1970s and the 1980s, many wealthy people paid no income tax whatsoever. 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 + some income tax exempt under the regular tax system. There are also restrictions on claiming itemized deductions, accelerated depreciation, 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.

According to the Urban-Brookings Tax Policy Center, the Tax Cuts and Jobs Act greatly reduced the number of taxpayers liable for the AMT, from about 5.1 million taxpayers in 2017 to about 200,000 taxpayers in 2020. Consequently, AMT tax revenue declined from $38.5 billion in 2017 to $5.2 billion in 2020. (T21-0214 - Aggregate AMT Projections, 2017-2031 | Tax Policy Center)

There is no specific formula to determine if a taxpayer must pay regular income tax or the AMT. However, these common items are not deductible under the AMT system:

• standard deduction
• state and local taxes
• interest on loans for boats or RVs
• investment interest expense
• depletion
• net operating loss deductions

Moreover, some additional income may be includable under the AMT system that was excluded under the regular system, such as:

• interest from private activity bonds
• qualified small business stock
• exercise of incentive stock options
• income that results from using accelerated depreciation over straight-line depreciation for certain property

There are some deductions 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, exceeds the AMT exemption amount, then it is likely 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.

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.

However, the Tax Cuts and Jobs Act reduced the difference between regular tax liability and AMT liability for many taxpayers because under the regular tax system, personal exemptions and miscellaneous itemized deductions subject to the 2%-of-AGI limit were eliminated and deductions for state and local taxes were capped.

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 2024, the AMT exemption amount is limited to the lower of the child's earned income + $9,250 or $85,700, while the exemption amount for other single taxpayers is $85,700. (Ref: Internal Revenue Bulletin: 2023-48 | Internal Revenue Service )

Alternative Minimum Taxable Income Formula

Form 6251 starts with adjusted gross income, the income before deductions for itemized deductions or the standard deduction. Because these deductions are not included in the AMT calculation, they need not be subtracted.

• Taxable Income
  • + Positive Adjustments
  • − Negative Adjustments
  • + Tax Preferences
• = Alternative Minimum Taxable Income

Adjustments

AMT tax is 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 differs under the AMT and regular tax system. As can be seen from this formula, if the regular deduction exceeds the AMT deduction, then the adjustment is positive; otherwise, it is negative.

Deduction Adjustment = Regular Deduction − AMT Deduction

Likewise, if the AMT income exceeds 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 exceeds 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.
• 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.
• 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 the option is exercised, then there is no different tax treatment under the 2 systems since taxable income = the stock sale price minus the option price.
• Long-term contracts, except for home construction contracts, require using 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 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.

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 they arise; however, under the AMT system, only 1/3 of the circulation expenditures can be deducted annually, so the entire expense can only be deducted over a 3-year period.

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 may differ 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 may 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 may be less than the regular net operating loss (NOL) because preferences and adjusted items have to be added to the regular income tax NOL. Thus, 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 is used for any tax year.

AMT Exemption

Each taxpayer is entitled to an AMT exemption amount, adjusted for inflation, that reduces the income subject to the AMT.

• Exemption and phaseout amounts are indexed for inflation, as of 2013.
• Since 2018, exemptions are adjusted less for inflation as the amounts will start using the new chained inflation rate (C-CPI-U), which will cause these values to rise more slowly than they would have under the old method of measuring inflation.
• Exemptions are decreased by $.25 for each dollar of income exceeding the phaseout amount.
• The amount (= AMTI − exemption) subject to the 26% AMT rate is also adjusted for inflation.
• Amounts over the 26%/28% dividing line are taxed at the 28% AMT rate.
• The lower AMT exemption for children subject to the kiddie tax, whether they paid the kiddie tax or not, has also been replaced, for 2018 through 2025, by the AMT exemption that applies to everyone else. Previously, the AMT exemption for children subject to the kiddie tax was $7500 + earned income.

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.

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.

The excess of the AMT over the regular tax is the AMT liability reported on the alternative minimum tax line on your tax return. You pay the higher tax.

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

1. Adjusted Gross Income (Line 38 on Form 1040)
   • ± Adjustments
   • + Tax Preferences
2. = Alternative Minimum Taxable Income
   • − AMT Exemption
3. = Alternative Minimum Tax Base
   • × AMT Rate
4. = Tentative AMT
   • − AMT Foreign Tax Credit
5. = AMT
6. Payable Tax = Greater of Regular Tax (1) or AMT (5)

Historical Notes

• Under the tax package passed by the Republicans at the end of 2017, the Tax Cuts and Jobs Act, certain provisions, started in 2018, eliminated the corporate alternative minimum tax and raised the exemption for individuals: $70,300 for singles and $109,400 for joint filers. The phaseout threshold also increased to $500,000 for singles and $1 million for joint filers. Except for the elimination of the corporate AMT, these provisions expire after 2025.
• The Tax Cuts and Jobs Act eliminated certain deductions that were previously available, including personal exemptions and itemized deductions subject to the 2% AGI floor, such as tax preparation fees and unreimbursed job expenses.