The Alternative Minimum Tax - What is it and How Can You Avoid It?
The Alternative Minimum Tax (AMT) is a parallel tax system in the United States that was designed to ensure that high-income taxpayers pay their fair share of taxes, even if they are able to use deductions and credits to significantly reduce their regular tax liability. In this blog post, we'll take a closer look at how the AMT works and what you need to know about it.
What is the Alternative Minimum Tax?
The Alternative Minimum Tax was introduced in 1969 as a way to ensure that wealthy taxpayers who were able to take advantage of tax breaks and deductions would not be able to escape paying their fair share of taxes. The AMT is essentially a separate tax calculation that runs parallel to the regular income tax calculation. Taxpayers must pay the higher of the two taxes, either their regular income tax or the AMT.
How does the Alternative Minimum Tax work?
The AMT is calculated by adding back certain deductions and tax credits that are allowed under the regular income tax system. For example, under the regular income tax system, taxpayers are allowed to deduct state and local income taxes, property taxes, and certain other expenses. However, under the AMT system, these deductions are disallowed.
The AMT also has its own set of exemptions and rates. Taxpayers are allowed an exemption amount that reduces their AMT liability. For the 2021 tax year, the exemption amount is $73,600 for single filers and $114,100 for married couples filing jointly. However, the exemption amount is phased out for high-income taxpayers.
The AMT has two tax rates: 26% and 28%. Taxpayers pay the 26% rate on the first $199,900 of their AMT income (or $99,950 for married couples filing separately), and the 28% rate on income above that amount.
Who is affected by the Alternative Minimum Tax?
The AMT was originally designed to affect only high-income taxpayers, but over time, the income thresholds for the AMT have not kept pace with inflation. As a result, more and more middle-income taxpayers are finding themselves subject to the AMT. However, the AMT is still primarily a tax on high-income taxpayers.
How can you avoid the Alternative Minimum Tax?
There are several strategies that taxpayers can use to minimize their exposure to the AMT. One strategy is to defer income and accelerate deductions. Since the AMT disallows certain deductions, accelerating them into a year when you are not subject to the AMT can help reduce your overall tax liability.
Another strategy is to be mindful of the types of investments you hold. Certain types of investments, such as municipal bonds, are tax-exempt under the regular income tax system, but they may be subject to the AMT. Taxpayers can work with a financial advisor to develop an investment strategy that takes into account the potential impact of the AMT.
In conclusion, the Alternative Minimum Tax is a separate tax calculation that runs parallel to the regular income tax system. It was designed to ensure that high-income taxpayers pay their fair share of taxes, even if they are able to use deductions and credits to significantly reduce their regular tax liability. While the AMT primarily affects high-income taxpayers, more and more middle-income taxpayers are finding themselves subject to the AMT. Taxpayers can work with a financial advisor to develop strategies to minimize their exposure to the AMT.