The Alternative Minimum Tax (AMT) is expected to impact 5.2 million taxpayers in 2017 according to the Tax Policy Center. Although the Tax Cuts and Jobs Act doesn’t eliminate the AMT entirely, provisions within the new law drastically reduce the number of taxpayers impacted by the AMT in 2018. The number of taxpayers who fall under the AMT is expected to drop from 5.2 million to 200,000 in 2018 – a 96% drop.
The year was 1969 – the country was in the middle of the Vietnam War, Richard Nixon was president, and the song of the year was “Sugar Sugar” by The Archies. With political and social angst on the rise, Congress found itself inundated with letters from constituents demanding change – not so much about the Vietnam War but more about the 155 individuals with income over $200,000 who paid no federal tax in 1966.
Due to rising pressure, Congress subsequently enacted a minimum tax that would be applied to preferential income items. These preferential income items, i.e. capital gains, were those items that were not taxed as heavily under the regular tax code.
In 1979 Congress expanded the add-on minimum tax and passed the modern version of the AMT. The original add-on tax was later repealed in 1983 but the AMT remained an integral part of the tax code as we know it today.
The real issues with the AMT started in 2001 when Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). The first of the two Bush Jr. era tax cuts substantially reduced regular income taxes but provided only temporary relief from the AMT. Many of the provisions were intended to phase in over several years but the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) accelerated these tax breaks.
Since taxpayers pay the higher of the regular tax or the AMT, a reduction of regular tax inadvertently pushed more and more taxpayers into the AMT. From 2000 to 2010 the number of taxpayers impacted by the AMT rose from just over 1 million to 4.2 million.
How is the AMT Calculated
The AMT is a tax code that exists apart from the regular tax code. Essentially, taxpayers must calculate their tax two ways and pay the higher of the two . The name may sound deceiving but the Alternative Minimum Tax is, by no means, a way to minimize your tax liability.
Think of the AMT as the bouncer of the tax code – it gives taxpayers an extra pat-down before letting them into the club. Some income is added back and certain deductions are disallowed. By the time you know it you’re paying an additional cover charge.
In layman’s terms – higher income taxpayers will compute their tax using both AMT rules as well as regular tax rules, and then pay the higher of the two. Here are just some of the rules applicable to the AMT.
- There are no standard deductions or personal exemptions under the AMT rules. Instead there are large exemptions for married couples, single filers and married filing separately ($84,500, $54,300, and $42,250 respectively).
- These exemptions phase out over certain dollar thresholds so that taxpayers will lose $.25 in exemptions for every dollar their income exceeds the phaseout ($120,700 Single, $160,900 MFJ, $80,450 MFS).
- Not allowed to deduct 2% miscellaneous itemized deductions (tax prep fees, unreimbursed job expenses, union dues, etc.).
- No deduction for state and local income taxes.
- Medical deductions are deductible but only to the extent they exceed 10% of AGI (for regular tax, those who are 65 years of age or over may deduct medical expenses exceeding 7.5% of AGI).
- Mortgage interest can be restricted in certain circumstances (primarily through the use of a home equity loan).
- The top tax rate under the AMT is 28%.
The major changes in 2018 are to the exclusions and the phaseout amounts. Beginning in 2018, the exemption amounts are increased to $109,400 if married filing jointly or surviving spouse, $70,300 if single or head of household, and $54,700 if married filing separately (for 2017 these amounts are $84,500, $54,300, and $42,250 respectively).
The greatest impact comes in the form of a temporary increase in the phaseout thresholds to $1,000,000 if married filing jointly or surviving spouse and $500,000 for all other individuals (for 2017 these amounts are $160,900 MFJ, $120,700 Single and $80,450 MFS/Trust & Estates).
With these two changes combined it’s almost impossible for taxpayers who don’t itemize to fall into the AMT. Let’s look at an example:
AMT Using the Standard Deduction
Jim and Jane have a combined adjusted gross income of $339,000 in 2018. Their entire income comes from wages and they have no long-term capital gains or other income taxed at preferential rates. They rent a beach house in Florida and only give $1,000 a year to charity. They take the $24,000 standard deduction which brings their taxable income down to $315,000. Under the new tax changes their regular tax would be $64,179.
Now let’s compute their taxable income under AMT. Assuming they have no add backs or preferential items they will have an Alternative Minimum Taxable Income (AMTI) of $229,600 ($339,000 AGI – $109,400 exemption). Since their AMTI is under the $1 million threshold they can claim the entire exemption amount. After applying the 2018 AMT tax rates you’d get a total AMT of $60,458. Since the regular tax of $64,179 is greater than the AMT tax of $60,458 Jim and Jane wouldn’t be subject to the AMT.
I specifically used taxable income of $315,000 because taxable income in excess of this amount is subject to a marginal tax rate of 32% – greater than the top AMT rate of 28%. Since the regular tax will be greater than the AMT on taxable income in excess of $315,000, Jim and Jane wouldn’t be subject to the AMT if their taxable income was greater than $315,000 or less than $315,000.
Since the new tax changes will significantly reduce the number of households that itemize deductions it will also significantly reduce the number of taxpayers subject to the AMT.
AMT Using Itemized Deduction
The AMT hits taxpayers between $200,000 and $500,000 the hardest, specifically in states with high income tax. These are typically taxpayers with substantial real estate taxes, home mortgage interest deductions, and state income taxes. The AMT limits these deductions and consequentially creates a higher tax liability.
The AMT disallows 2% miscellaneous itemized deduction, disallows personal exemptions, disallows mortgage interest on home equity loans, and disallows state and local tax deductions. However, the new tax law changes in 2018 eliminates all these provisions with the exception of the state and local tax deduction (which is capped at $10,000). Essentially, the old AMT rules becomes a part of the regular tax code.
In a real sense those who have been subject to the AMT in the past might still be subject to the AMT rules under the regular tax code. Therefore, even if a taxpayer doesn’t pay AMT in 2018 it doesn’t mean they will be better off under the new tax changes.
The AMT’s reach will be reduced by 96% but that doesn’t mean it’s going away entirely. To see how your specific tax situation will be impacted by the new tax law consult with a tax advisor.
This article is for education purposes only and should not be used as tax, financial, legal or other paid financial advice. Consult an advisor for your specific tax or financial situation. Photo Copyright: <a href='https://www.123rf.com/profile_kmiragaya'>kmiragaya / 123RF Stock Photo