BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Alternative Minimum Tax Explained

Following
This article is more than 10 years old.

About this time next year, many taxpayers will be just getting over the shock of paying perhaps thousands of dollars and more in 2012 income taxes because of the Alternative Minimum Tax (AMT). The amount of additional tax and number of taxpayers affected, will substantially increase if Congress does not increase the 2012 AMT exemptions as it has done for prior years. I know eyes glaze over when people hear AMT, but it is fairly simple to explain.

Picture the USA and a parallel universe: AMTUSA. Actually, I will make it simpler than this. Federal income tax law requires taxpayers to calculate income tax liability under one set of rules and then calculate income tax liability under another set of rules, AMT. The taxpayer is then required to pay the higher of the two results. So really it is parallel rules in the same universe.

The expressed purpose of AMT is to limit taxpayers from reaping too much benefit under the regular income tax law. For purposes of AMT various deductions, exemption, income exclusions and credits for regular income tax purposes are eliminated or reduced in calculating tax under AMT. AMT also has its own tax brackets; for individuals, AMT taxable income up to $175,000 is taxed at a 26% rate and AMT taxable income in excess of $175,000 is taxed at a 28% rate.  However, many feel AMT as currently configured does not fulfill its expressed purpose because it usually affects mostly middle and upper middle income taxpayers. In short, the explanation for AMT has nothing to do with how it actually works. So, again, AMT is simply a parallel set of rules (in the same universe) that usually affects middle and upper middle income taxpayers. Are you with me so far?

Many individual taxpayers have higher income tax liability under AMT because state income taxes and property taxes are not allowed as deductions for AMT. Some legislators have suggested the elimination of state income tax and property tax deductions for regular tax purposes. This would make the regular tax more like AMT. This could lead to one set of income tax rules with regular tax liability more like the tax liability under AMT.  So we could end up with only one set of income tax rules in the same universe.

Admittedly, the above explanation is an oversimplification of AMT. Taxpayers should know their specific tax footprint and be aware of the AMT adjustments that are applicable to their situation. If there is potential for significant AMT tax liability you should (have your accountant, or tax attorney) run projections of AMT and regular tax liability. Through tax planning items of income and deduction can be eliminated or reduced, or accelerated or deferred between tax years to reduce overall tax liability.

So why do taxpayers like Warren Buffett and Mitt Romney not pay additional tax under AMT? This is because preferential income like qualified dividends and capital gain are subject to the same preferential rate of 15% for AMT as well as for regular tax. This seems to be inconsistent with the expressed purpose of AMT. The Buffet Tax, witch did not make its way out of the Senate, would have required wealthy taxpayers with substantial preferential income to pay more tax. Does this mean the rich are in a different world for tax purposes as compared to the rest of the population?