And here’s how Trump’s payroll tax holiday could affect Social Security.
What is alternative minimum tax?
The alternative minimum tax (AMT) is a special tax that prevents people with high incomes from abusing deductions and credits to pay little or no income tax. The AMT provides an alternative method of calculating the minimum amount of income tax owed: if an individual’s tax liability falls below the minimum for a given income level, the difference is made up by the alternative minimum tax.
In 1969, the U.S. Congress noticed that many people who had high incomes were legally using a variety of tax deductions and loopholes to reduce their federal tax liability to zero. Congress established the minimum tax — renamed the AMT in a 1979 tax reform law — to make the tax system fairer and to ensure the wealthy paid their share.
The original tax was never indexed to inflation, and over time more and more middle-income earners were snared by a tax intended for the wealthy. Reforms in 2012 implemented AMT exemption amounts that were indexed to rise with inflation.
Individuals are not required to pay the AMT on adjusted gross income below a certain level, the so-called AMT exemption amount. For the 2017 tax year, taxpayers with income less than the following exemption thresholds need not worry about the AMT:
- Single taxpayers and head of household: $54,300
- Married taxpayers filing jointly and surviving spouses: $84,500
- Married taxpayers filing separately: $42,250
- Trusts and estates: $24,100
Any amount of income over the applicable AMT exemption amount may be taxed at the AMT rates. For incomes that are above these exemption amounts, a taxpayer must calculate the AMT and regular income tax, and then pay whichever is higher.
After calculating their regular income tax, taxpayers add AMT preference items to their taxable income, subtract the AMT exemption amount, and recalculate their tax using an AMT tax rate. The AMT tax liability is the excess of this amount over the amount of tax owed according to regular income tax rules.
AMT preference items include deductions for state and local taxes, personal exemptions, and deductions for miscellaneous business expenses. These are common tax preference items that are added back to income for the purpose of calculating the AMT:
- The exercise of incentive stock options.
- Claiming multiple dependents, especially for joint filings.
- Claiming business depreciation.
- Taking out a home equity loan for something other than home improvements.
- Claiming deductions for investment expenditures or unreimbursed employee business expenses.
Looking to figure out how much you owe in taxes? Check out Bankrate’s tax calculators.
Alternative minimum tax example
Elon’s regular income tax is $45,000, but when he calculates his tax using the AMT rules, it amounts to $38,000. Since it’s lower than standard income tax, Elon does not have to pay any AMT, although he still must pay the full regular income tax of $45,000. Alternatively, Elon’s regular income tax is $45,000, but using the AMT rules, Elon owes $58,000 in tax. Elon must pay $13,000 of AMT on top of the $45,000 of regular income tax.