What Is The “Alternative Minimum Tax” In A Nutshell?

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It can come as quite a shock at tax time when you find out that you have been hit with the “alternative minimum tax.”  The alternative minimum tax, or AMT, came into effect back in the 1970s.

The reason it came into effect was to create tax fairness.  The then-Secretary of the Treasury testified that 155 high income earners were escaping taxation under the current tax system.  Congress was intent on closing the “loopholes” these taxpayers enjoyed.

The result today is a parallel system of taxation.  Basically you have to figure your tax under both the regular system and the alternative system.  Then you get to pay tax on the higher of the two.  What fun!

The AMT starts with your regular taxable income and then makes you give up tax breaks until you arrive at your  “alternative minimum taxable income” or AMTI.  

After you find your AMTI, the tax code gives us an exemption.  In 2013 it  is $51,900 for single taxpayers and $80,800 for married filing jointly taxpayers.  But your exemption also gets reduced by 25% if your income gets “too high.”

Here are some of the tax breaks that you might lose:

  1. Tax-exempt interest.  Certain types of private activity bonds are not exempt for AMT purposes.  So that investment you thought would be tax free – is not.
  2. Interest deduction.  If you have a home equity loan that was not used to buy, build, or substantially improve your home, the interest you pay is no longer deductible.
  3. State and local tax deduction. You get no deduction for state and local income taxes, or real estate or other property taxes.  In Texas, this will hurt because property taxes are outrageous.
  4. Medical expenses. Have a lot of health issues?  Well the government doesn’t think that you should get a break for that.  Get ready to pay tax on your medical expenses.
  5. Miscellaneous itemized deductions.  Did you have any employment-related expenses that your company would not reimburse you for?  Example – a teacher buying items for their classroom.  Forget about it under the AMT.
  6. Personal and dependency exemptions. Have a lot of kids?  Government doesn’t like them.  More taxes for working parents.
  7. Standard deduction.  Sorry Charlie, give it back to Uncle Sam.
  8. Incentive stock options.  Lots of employers give out stock options.  If you think you are not taxed on those, you are wrong.   You may have to pay AMT on the value of the stock you receive minus what you paid for it.  This is true even if the stock becomes worthless after you exercise the option.

There are even more “tax breaks”  you lose under the AMT system.

Originally, the system was set up for tax fairness.  Where is the fairness now?  I think it has the opposite effect for most AMT taxpayers.