I have been called out more than one time by clients when I start talking about AMT. Most people do not know what AMT is. In my opinion, that’s how it should be. However, this year you might be forced to become acquainted with AMT, so you should understand what it is and how it affects you.
Q: What is the AMT and why should I care?
A: “AMT” stands for “alternative minimum tax”. I hear you saying to yourself “sounds kind of edgy” and it is, but not in a nice way.
The alternative minimum tax began as the “minimum tax” back in 1969, and was aimed at high income taxpayers with a relatively low tax bill thanks to deductions and exemptions. The AMT originally targeted 155 high-income families but now affects around 15% of all taxpayers.
In 2011, the exemption for AMT was set at $74,450 for married filing jointly, and $48,450 for single or head of household. The AMT exemption typically shields you from paying AMT. The AMT exemption is set to drop dramatically in 2012, to $45,000 for MFJ and $33,750 for S/HOH. You see, the AMT exemption is not indexed to inflation so Congress has to pass legislation to change it. This legislation, called the AMT patch, may raise the AMT exemption limits back to where they were in 2011, but there is no guarantee.
Q: What happens if the AMT patch is not passed by Congress?
A: The number of taxpayers who pay the additional AMT will increase from 4 million in 2011 to 31 million in 2012. Most of the taxpayers affected are in the middle class, have dependents, and live in high tax states. AMT often does not affect very high income taxpayers because 1) the AMT tax rate of 26 or 28 percent is actually lower than their marginal tax rate, and/or 2) much of their income is long-term capital gains and qualified dividends taxed at the same rates (0 or 15 percent) under AMT.
Q: How does the AMT work?
A: AMT is calculated by taking your taxable income, adding back certain deductions and exemptions, subtracting the AMT exemption, and multiplying by the AMT tax rate of either 26% or 28%. Net long-term capital gains and qualified dividends are taxed the same under AMT as under “normal” tax.
The AMT takes away several common deductions which I am including here. Be aware that these are not the only deductions affected by AMT:
- The standard deduction, for taxpayers who do not itemize
- State income and property taxes
- Mortgage interest not used for purchasing or improving your primary or second home
- Accelerated depreciation on business assets
- Miscellaneous deductions for job-related expenses, investment expenses, tax preparation expenses, etc.
- Medical expenses under AMT are subject to 10% of adjusted gross income, versus 7.5%.
- All personal and dependent exemptions
Q: I think I might have AMT this year. What should I do?
A: Don’t panic. Many taxpayers in 2011 whose income was above the AMT exemption did not have to pay additional tax because they had little income above the AMT exemption amount, and they had capital gains and/or qualified dividends that were taxed at the same rate for normal and AMT purposes.
Here are a few things to remember if you think you might have AMT in 2012:
- If you make quarterly estimated payments, don’t worry about making your last state income tax payment in December to get the extra deduction because it won’t help you. The state income tax deduction is eliminated in the AMT calculation
- The same principle holds for property taxes. Don’t worry about paying property taxes early (before December 31st). The property tax deduction is eliminated in the AMT calculation.
- Don’t assume that taking out a home equity loan to buy a car, a boat or pay off credit card debt will lower your tax bill. This type of mortgage interest deduction is eliminated in the AMT calculation.
- If you have consistently been subject to AMT in the past, beware of investing in oil partnerships and tax-exempt private activity bonds. Some of the tax benefits of these investments are reduced or eliminated in the AMT calculation.
- The charitable deduction is not affected by AMT, so increasing your charitable giving will help you.
- Most personal, non-refundable tax credits are not affected by AMT, such as the American Opportunity Credit, the Lifetime Learning Credit, and the Child Tax Credit.
- There has been talk of angry taxpayers protesting at the capital with pikes and pitchforks. I don’t recommend that approach, but you might want to drop a line to favorite congressman about passing the AMT patch.
Q: What if I still don’t understand what you’re trying to say here about AMT, or if I lost consciousness by the 2nd sentence?
A: Relax, this is normal. That’s why God created tax preparers.