Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Alternative Minimum Tax

What it is:

The alternative minimum tax (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.

How it works (Example):

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.

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.

[InvestingAnswers Feature: The Most Important Tax Changes to Know Before Filing Your Tax Return]

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 agency bond 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.

[InvestingAnswers Feature: The AMT Trap and How to Avoid It]

Related Terms View All
  • Mad Hatter
    In Lewis Carroll's book Alice's Adventures in Wonderland, the main character, Alice,...
  • National Accounting
    In the United States, federal government agencies typically use national accounting to...
  • JAJO
    Assume you own 100 shares of Company XYZ. At the end of the quarter (say, March 30),...
  • Recapture
    Taxing authorities can implement tax recaptures in which the taxing authority requires a...
  • Healthcare Power of Attorney (HCPA)
    Individuals sometimes become too unwell or unfit to make decisions regarding their...