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| Alternative
Minimum Tax (AMT) |
What It Is:
The AMT is income tax owed using a parallel tax code designed to ensure that
every taxpayer, particularly rich ones and corporations, pay at least some
income tax each year.
Congress created the AMT in 1969 as a way to ensure that people with high
incomes and corporations could not avoid taxes by using various tax shelters.
How It Works/Example:
Taxpayers must calculate their AMT separately from their �regular� taxes
calculated on IRS Form 1040. The AMT, which is calculated using IRS Form 6251,
starts with the taxpayer�s taxable income (income after personal exemptions
and standard or itemized deductions) and adds back various adjustments to arrive
at a net alternative taxable income. The AMT rules disallow many personal
exemptions and many deductions. The resulting higher taxable income is then
taxed at flat rate. The taxpayer compares the tax calculated under the AMT
method to the tax calculated under the �regular� method and owes the higher
of the two.
The exemption amounts for figuring AMT change each year, so it�s important to
refer to the IRS instructions or a tax professional.
Why It Matters:
The goal of the AMT is to ensure that everyone pays at least some income tax.
This is why the AMT calculations effectively eliminate several types of
deductions and credits, creating a tax liability for a person who would
otherwise pay little or no tax.
The AMT system is complicated and controversial. Its elimination of many
deductions and credits particularly affect people with large amounts of itemized
deductions, people with many children or dependents, people who exercise
incentive stock options, and those who pay high state and local taxes or high
personal property taxes. Also, because the AMT thresholds have not been
frequently adjusted for inflation, more and more middle-income taxpayers are
subject to AMT.
The AMT is a good example of why taxpayers should take the time to plan for
taxes and consult a tax professional. In some cases, those liable for AMT may be
able to lower their total tax bills by claiming itemized deductions on Form
1040, even if their total itemized deductions are less than the standard
deduction. This is because the AMT system does not allow the standard deduction,
and if a taxpayer claims the standard deduction on Form 1040, he or she cannot
claim itemized deductions for the AMT, according to the IRS. This could result
in a lower tax bill even though the taxpayer has claimed fewer deductions.
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