Alternative Minimum Tax (AMT): Defined And Explained

It’s hard to avoid paying taxes. If you believe you may be put into a higher tax bracket — whether you switched to a job with a much higher income or earned way more in passive income, for example — there’s a type of tax that should be on your radar: the alternative minimum tax (AMT). While it may not apply to you for now, it’s still useful to learn about the alternative minimum tax in case it does in the future.

What Is The Alternative Minimum Tax (AMT)?

The alternative minimum tax (AMT) is a minimum, or floor, of taxes a taxpayer needs to pay no matter their deductions or credits. The AMT is a way for the IRS to make sure those in higher tax brackets are paying a certain amount of income tax. There are set AMT exemption amounts and tax rates that determine who is subject to paying this tax.

This is how it works: Your potential tax obligations are calculated twice – once at the regular calculations and again through the AMT. The latter will recalculate your income tax when it adds certain deductions back into your adjusted gross income. Any income that’s above the exemption amount is subject to the alternative minimum tax. There is also an exemption amount at which the AMT begins to phase out.

Enacted in 1969, the AMT's aim is to prevent the wealthy from getting too many tax breaks. Instead of avoiding taxes or paying as little as possible, the minimum tax threshold ensured that the wealthy wouldn't be able to avoid Uncle Sam. The AMT essentially reduces the amount of exemptions certain taxpayers can claim and uses a different tax structure for their income.

However, in 2017, the Tax Cuts and Jobs Act (TCJA) reduced the impact of the alternative minimum tax significantly. More specifically, the act had provisions that had a higher exemption for AMT, reduced some of the largest AMT exemptions, and increased the income level when the exemption starts to phase out. However, these exemptions are only applicable for 2018 to 2025, unless Congress decides to extend them.

Who Is Subject To The Alternative Minimum Tax?

Those who are subject to the AMT are taxpayers who have a certain income threshold. So if you have income over the exemption amount, you could be subject to the alternative minimum tax.

Although your income may not qualify for AMT now, it could in the future. For example, your household income may increase because of a new job or promotion and you’ll qualify for a number of deductions and credits. Even if your salary stays the same, income from investments could push your income up. Some common scenarios include selling investments and realizing capital gains, selling stock shares at a profit, or even exercising qualified employee stock options.

As with any tax information, please consult a tax professional with any questions you have regarding your liability. The rules and regulations surrounding the alternative minimum tax can change over time.

How Is The AMT Calculated?

The simplest way to calculate the AMT is using reputable tax software. In any case, this is a general breakdown of how it’s done:

●      Use the IRS Form 1040 to calculate your ordinary, or taxable income.

●      Then, use Form 6251 to add back in tax breaks (exclusions and deductions) the AMT rules says you should.

●      Take this amount and subtract it from the AMT exemption amount for the applicable tax filing status (you can use the table in the next section).

●      The amount you have left is what you would use to calculate your AMT tax. The two tax rates are 26% and 28% — Form 6251 will show you which tax bracket to use, as it will depend on your AMT taxable income. 

●      You can take the credit for foreign taxes if it qualifies for your situation.

●      The amount you have now is the income taxes you may owe under AMT.

●      Compare the income tax you may pay under regular tax regulations compared to the AMT ones. Whichever one is higher is what you pay. For example, if the AMT is higher, you are required to pay the alternative minimum tax.

What Is The Alternative Minimum Tax Rate For 2023?

The following table lists the AMT exemption income amounts for 2023 for different taxpayer statuses. These higher amounts could mean that your income may not trigger status (although it’s best to check with a tax professional just in case).

How Does AMT Affect Tax Break Eligibility?

If you end up paying the alternative minimum tax, you stand to lose certain tax credits and deductions that could potentially reduce your ordinary or taxable income. These tax deductions and breaks typically lower the amount you could pay in taxes. Some of these tax breaks include property taxes, real estate taxes, and certain deductions for state and local taxes. Although some of these deductions you may not qualify for unless you itemize them — such as property taxes — the others could significantly affect how much you ultimately pay the IRS.

The Bottom Line

The alternative minimum tax only takes effect if your income in a calendar year goes up to above the current exemption amounts, and if the income taxes calculated are higher than the ordinary tax rate. You may also end up paying more since you won’t qualify for certain deductions such as ones offered through the state and local level, as well as personal property taxes.

Unfortunately, if you find out you have to pay AMT when filing your tax return, there isn't much you can do. That's why it's important to understand whether your financial situation could trigger AMT so that you’re prepared. It can also help you plan ahead such as lowering your taxable income — some popular strategies include contributing more to tax sheltered accounts like a Traditional IRA, health savings account (HSA) or a 401(k).

To help keep track of your finances whether or not you have to pay extra taxes, take advantage of free tools to remove some of the manual work involved in tracking your finances. Consider creating an account on the Rocket Money℠ app — it’s free.