Educate Yourself: Alternative Minimum Tax

As a tax professional, clients continuously ask me about the details surrounding the alternative minimum tax. What is it? Who does it impact? How will it impact me? Let’s take a look at how the alternative minimum tax can play a part in your financial decision-making, annual tax implications and, most importantly, your bottom line. First, we should start at the basics. Here are some of the most frequently asked questions:

Q: What is the Alternative Minimum Tax (AMT)?

According to Merriam-Webster, the textbook definition would read as follows: A U.S. federal income tax that was originally imposed to prevent wealthy taxpayers from using tax shelters to avoid paying taxes, that excludes many deductions and exemptions allowed in computing regular tax liability, and that must be paid instead of the regular tax liability by individuals and businesses whose alternative minimum tax liability is greater than their regular tax liability.

What many may not know, however, is the AMT dates back to the Nixon era. Richard M. Nixon, who was known for having many write-offs for his generation, was able to coup thousands in tax savings while many were not aware of these deductions. Today, we know some of these deductions as medical expenses, unreimbursed employee expenses, multiple interest sources and charitable donations. Intended for the wealthy and upper class, the AMT is now known to limit the number of write-offs one could take. As a result, fewer deductions can be taken, income thresholds will remain high and higher taxes will be owed.

Q: Who exactly does the AMT impact?

Regionally, the AMT typically hits hardest in areas of higher state income taxes, property taxes and wages. The Northeast and California comes to mind when providing an example. Generally speaking, if you look at a yearly tax bracket, you can see how hard you are being hit from the AMT. Clearly, the higher the income and filing status, the more intertwined you become in the AMT. Take a look for yourself:

2016 Taxable Income Brackets and Rates (Estimate)
Rate Single Filers Married Joint Filers Head of Household Filers
10% $0 to $9,275 $0 to $18,550 $0 to $13,250
15% $9,275 to $37,650 $18,550 to $75,300 $13,250 to $50,400
25% $37,650 to $91,150 $75,300 to $151,900 $50,400 to $130,150
28% $91,150 to $190,150 $151,900 to $231,450 $130,150 to $210,800
33% $190,150 to $413,350 $231,450 to $413,350 $210,800 to $413,350
35% $413,350 to $415,050 $413,350 to $466,950 $413,350 to $441,000
39.6% $415,050+ $466,950+ $441,000+
Source: Author’s Calculations.

 Q: How can I avoid or reduce my AMT?

While many deductions and credits are phased out at certain income levels, there are a handful of write-offs that are never truly lost. Capitalizing on these deductions is absolutely vital to your ability to avoid or reduce your AMT. These include the following:

  1. Tax Shelters:

You may know a “tax shelter” as a 401(k), 403(b), IRA or 457. These shelters provide a great outlet to reduce income levels and possibly prevent or lower your AMT liability. Paying yourself first, not the government!

  1. Other Savings Accounts/Plans:

Many people are unaware of certain accounts that can utilize pretax dollars. This includes health savings accounts (HSA) for medical expenses, flexible spending accounts and long-term disability. These sources save you from paying taxes up-front and also through the AMT.

  1. Pre-Tax Transit Benefits:

This one is for all my city employees! You can deduct up to $255 in pre-taxed transit benefits per month from your yearly income. A much needed deduction seeing the cost of transportation these days.

  1. Managing Capital Gains, State Tax Payments and Incentive Stock Options (Qualified Stock Options):

That’s a mouth full, huh? Essentially, how you cash out on certain payments and gains can greatly reduce your tax liability. Utilizing certain strategies, you can greatly reduce your tax and AMT liability. See your tax advisor should these circumstances arise.

  1. Schedule A Deductions:

These are the most common deductions you will see on a tax return. These include your home, charitable gifts, medical expenses, employee expenses, etc. When referencing the AMT, however, only certain deductions will influence your bottom line as many of these write-offs are whipped out! To reduce your AMT, only charitable donation, home mortgage interest (not property taxes!), and qualified medical expenses count!