In your tax planning, don't overlook how your tax-saving strategies might be impacted by the alternative minimum tax.
What is the alternative minimum tax?
Enacted back in 1969, the alternative minimum tax (AMT) is a separate income tax calculation that was designed to make sure that high-income taxpayers pay a minimum amount of taxes, even if they have sufficient deductions and credits to reduce their federal income tax liability to zero.
To calculate the AMT, start with regular taxable income, which includes all your familiar deductions and exemptions. Then make adjustments and add back certain "preferences" to arrive at your AMT income. Preferences include personal exemptions, state and local taxes, certain interest on home-equity loans, and miscellaneous itemized deductions.
After adding back the preferences, you're entitled to an exemption amount, though the exemption phases out at higher-income levels.
You then calculate your AMT by applying tax rates of either 26 percent or 28% depending on your AMT taxable income. The income thresholds for these rates change each year. Finally, you compare your AMT to your regular tax and pay whichever is greater.
Who is impacted by the AMT?
Congress created the AMT to ensure that wealthier taxpayers, who often have the kinds of income and deductions that qualify for preferential tax treatment, would pay at least a minimum amount of tax. Congress also wrote exemptions into the law, so that middle-income taxpayers wouldn't be subject to the AMT. Today the AMT impacts a much broader cross-section of taxpayers.
Will the AMT impact you?
You need to consider the AMT if you have a lot of dependents or if you claim substantial itemized deductions. You may also be subject to the AMT if you realize hefty capital gains during the year or exercise incentive stock options. Claiming certain tax credits might trigger the AMT as well. And if you are an owner of rental real estate or a capital intensive business, you need to be aware that the amount of depreciation allowed under the AMT is limited.
Don't let the AMT cause your tax planning strategies to backfire. To find out whether you might be affected by the AMT, conduct a mid-year tax planning session.