Will the Gotcha Tax Hit You?

Income tax sits front and center of your mind this time of year. Another income tax affects you if you make enough and try to take certain deductions: the alternative minimum tax (AMT). It most often means you must pay more than usual. How do you know if this gotcha tax will hit you?

This levy, a kind of parallel tax system, applies when your annual income tops certain thresholds and essentially ensures you pay a minimum income tax. The point of it is to ensure that taxpayers who pay little or nothing, due to clever maneuvers, no longer can do so. You pay the higher of the regular tax or AMT, the rate of the latter generally 26% or 28%.

The AMT uses separate rules for definitions of income and expenses, rules for accounting and timing and for exemptions and tax rates. It also limits the tax benefit of certain types of income and deductions.

Sometimes derided now as an unintended tax trap for the middle class, the AMT was created in 1969 and never indexed to inflation. In recent years, Congress approved temporary patches to boost the exemption level and spare middle-income taxpayers.

Some conditions triggering the AMT: Whittling your high taxable income with a large number of dependents’ deductions, high income from long-term capital gains, large Schedule A deductions or a large amount of tax-free income from private activity bonds.

Other possible triggers: hefty itemized deductions for state and local taxes, medical expenses and miscellaneous expenses; mortgage interest on home equity debt; exercising (but not selling) incentive stock options; or foreign tax credits.

(AMT rules also define investment interest expense, depletion, stock option exercises and other items only of interest to business owners differently than do rules for regular income tax.)

Calculating the AMT, generally, involves determining your adjusted gross income, subtracting your itemized deductions, making certain negative and positive adjustments and including certain tax items.

The Internal Revenue Service Tax Tip 2014-10 helps you understand the AMT (especially helpful is the AMT assistant tool):

  • If your taxable income falls below the AMT exemption amount for your filing status, you usually don’t owe AMT. The 2013 AMT exemption amounts for each filing status are: single and head of household, $51,900; married filing separately (MFS), $40,400; and married filing jointly or qualifying widow(er), $80,800.
  • Electronic filing software such as that on IRS e-file will figure AMT for you if you owe it.
  • If you file a paper return, use the assistant tool on IRS.gov first to find out if you need to pay the AMT.

Use IRS Form 6251, “Alternative Minimum Tax – Individuals,” to see if your income warrants the AMT. On this form, add to your taxable income those items used to determine the Alternative Minimum Taxable Income (AMTI).

Starting with your taxable income before exemptions on line 41 of your IRS Form 1040, make the adjustments and add back in many deductions from Schedule A (such as some medical expenses, mortgage interest, taxes and miscellaneous deductions). If the tax calculated exceeds your ordinary income tax, you pay the AMT.

If you owe AMT you may also be able to file IRS Form 1040A and use the AMT worksheet in the 1040A instructions.

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Jim Blankenship, CFP, EA, is an independent, fee-only financial planner at Blankenship Financial Planning in New Berlin, Ill. He is the author of An IRA Owner’s Manual and A Social Security Owner’s Manual. His blog is Getting Your Financial Ducks In A Row, where he writes regularly about taxes, retirement savings and Social Security.

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