There are two tax regimes to which an individual taxpayer may be subjected: the regular income tax and the alternative minimum income tax (AMT). A taxpayer must compute their tax under each method and pay the higher of the two taxes. The AMT adds an additional tax burden to the taxpayer who is over the regular income tax.
Congress passed several laws starting in 1969 which developed into the AMT. The goal of the AMT was to provide tax equity by imposing a minimum tax. It was established to prevent taxpayers from using certain deductions to avoid paying taxes. There have been numerous reforms to AMT to achieve the overriding objective that no taxpayer with substantial economic income should be able to avoid paying a significant tax liability.
Alternative Minimum Tax Income (AMTI) is computed with certain adjustments and preference items. An adjustment item is an amount that is recomputed for AMTI purposes, such as depreciation, which will reverse in time. A preference is a deduction for regular tax purposes which is considered to have preferential treatment, such as state income and real estate taxes or miscellaneous itemized deductions. A tax preference does not reverse in the future.
A taxpayer who is subject to AMT may be eligible to reduce future regular income taxes through a minimum tax credit (MTC) for certain adjustments, but not preferences.This credit permits the taxpayer to reduce regular tax to not less than the AMT in years where the AMT is less than the regular tax. There is an unlimited carry forward period for this credit.
There are numerous reasons a taxpayer may be subject to AMT. As mentioned above, there are differences caused by adjustments and preferences. The AMT can be caused from something as simple as claiming too many dependents on the return, as the dependency exemption and the standard deduction are both considered preference items and not deductible in computing AMTI. A married taxpayer filing a joint return with five children and $100,000 of wages would be subject to the AMT.
Another common cause of AMT is having large amounts of long-term capital gains and qualified dividends. Since both regular tax and AMT subject these amounts to tax at the same rate, deductions which may be used to reduce regular tax, such as state and local income tax and real estate taxes, will not be permitted for AMTI purposes. For instance, a taxpayer who may have a large capital gain in a year, in addition to their normal income, could increase the AMT that may be paid in the current and/or subsequent year due to the timing of the deduction of state and local income taxes. If planning is not done properly to match the deduction of the state and local income tax to a requisite amount of income, a taxpayer could be subject to additional AMT related to the timing of the deductions.
If a taxpayer has a net operating loss carryover, it may also be a trigger for AMT. Under the regular tax method, the NOL may offset 100 percent of the taxable income for the year but is limited to 90 percent of AMTI for AMT purposes. Accordingly, the taxpayer would be subject to tax on 10 percent of this AMTI, even though they may have no regular income tax liability. Appropriate planning may minimize the effect of the additional tax.
Taxpayers need to be wary of items that may cause them to be subject to the AMT and plan accordingly to limit the effect of the AMT.
Allison J. Shoemaker can be reached at email@example.com or 215.441.4600.
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