Alternative Minimum Tax explained

For the majority of U.S. taxpayers, the AMT may never come into play. 

Even so, its complex rules have ended up causing worry for people in many tax brackets. Here’s what you need to know about AMT and whether your tax filing could be affected. 

What is AMT?

AMT is another way to calculate income taxes. It requires certain taxpayers to determine their liability twice: once using regular income tax rules, and once using AMT rules. They then must pay whichever amount is higher.

Here's how AMT works:

• You calculate your regular taxable income.

• You complete AMT Form 6251 which applies any adjustments or preferences to determine alternative minimum taxable income (AMTI).

• After the AMT exemption is subtracted from AMTI, the AMT tax rates are applied to determine tentative minimum tax.

• The taxpayer is subject to AMT if the tentative minimum tax exceeds the regular tax liability calculated on regular taxable income.

Not everyone is subject to AMT. You might be subject to AMT if you earn income above a certain level and/or from certain sources (i.e., tax preference items and /or adjustment items), including:

• Incentive stock options

• Intangible drilling costs

• Tax-exempt interest from certain private activity bonds (PAB)

• Depletion and accelerated depreciation on certain leased personal or real property¹

Why was AMT created?

A simplified version of the AMT, called the add-on minimum tax, was created in 1969 to ensure the country’s wealthiest citizens paid their fair share of taxes. The IRS had discovered that 155 taxpayers with income of more than $200,000 had not paid income tax in 1966 because they used deductions unavailable to the average citizen.² As a result, Congress passed the add-on minimum tax. This add-on tax applied to certain income items that the regular income tax system either taxed lightly or overlooked. The largest of these “preferences” was the portion of capital gains excluded from the regular income tax.

Revisions to the AMT throughout the years increased the number of affected taxpayers from 155 in 1969 to nearly 4.5 million by 2015. Noting that the number of affected people had grown so significantly, changes to the AMT as we know it today were included in the Tax Cuts and Job Act (TCJA) of 2017. These changes dramatically reduced the number of taxpayers who owe AMT at tax time.

AMT and the TCJA

The TCJA significantly — albeit temporarily —narrowed the scope of the AMT in at least three important ways:

1. Higher AMT exemptions. The AMT is indexed yearly for inflation. For the 2022 tax year, it’s $75,900 for individuals and $118,100 for married couples filing jointly.   

2. Higher income levels for exemption phaseout. Phaseout for the 2022 tax year starts at $539,900 for individuals and $1,079,800 for married couples filing jointly.

3. Eliminated or reduced AMT’s preference and adjustment items.  

   • Reduced – state and local taxes (SALT) including the real estate tax deduction adjusted to a maximum of $10,000.  

   • Eliminated – miscellaneous itemized deductions, personal exemptions, and home equity loan interest.

The AMT exemptions and phase out numbers above are inflation adjusted annually. These revised AMT provisions, along with nearly all TCJA individual income tax measures, are set to expire at the end of 2025 and return to their pre-2017 levels in 2026. 

Three common income scenarios that could trigger the AMT

It’s hard to predict who will and who won’t have to pay the AMT. Consider talking to a financial professional if you’re unsure about your status and watch for a few common AMT triggers. These include: 

• You have an income above the AMT exemption (see above). The 2018 TCJA reduced five out of the seven regular tax rates but it held AMT rates at 26% and 28%. This combination could potentially cause high income taxpayers to end up owing AMT. However, if you’re in that middle-upper income level, you’ll likely end up owing less than you would have prior to TCJA.

• You exercise incentive stock options (i.e., ISO’s) to buy stock at a discounted strike price. This is not a taxable event for regular tax purposes but is for AMT purposes.  If the discount is substantial, a significant adjustment item would exist and increase the potential for the taxpayer to be subject to AMT. 

• You have a high ratio of long-term capital gains to ordinary income. This trigger would only affect people with incomes of more than $1 million combined. A potential scenario would be a business owner who sold a business that had appreciated steeply over a period of 25-30 years. While qualified dividends and long-term capital gains are still taxed at preferential rates of only 15-20%, large amounts of such income may cause the phase out of the AMT exemption and indirectly cause the AMT to apply to other income. 

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