Oct 20, 2020
Long-term capital gains and certain dividends could push your income up, triggering the alternative minimum tax (AMT). If you're vulnerable to the AMT, here's what you need to know.
What is the alternative minimum tax (AMT)?
Alternative minimum tax, better known as the AMT operates alongside the regular income tax. The AMT requires a small portion of taxpayers to calculate their tax liability twice — once under the normal rules set forth by the IRS and once again under the AMT exemption.
After doing so, the tax filer is liable for the higher of the two outcomes. AMT rates are 26% or 28%. This limits certain deductions, credits, and other benefits that could reduce taxable income.
Who does the alternative minimum tax apply to?
Basically, anyone who files a federal tax return could potentially be subject to AMT. According to the IRS, AMT applies to taxpayers with high economic income by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax.
Why is the AMT in place?
The AMT was introduced in 1969 to prevent high-income taxpayers from avoiding the individual income tax. After 155 ultra-rich families got away with paying no taxes, the AMT was put in place to even out the playing field.
Prior to 2017, the AMT hit roughly 60% of the taxpayers making over $200,000 annually. Now with the Tax Cuts and Jobs Act (TCJA), the AMT rules have significantly changed. The revised rules result in far fewer people having to worry about the AMT affecting them. However, the changes are temporary and apply only to tax years 2018 to 2025 unless Congress extends them or makes them permanent.
What are the AMT exemption amounts for 2020?
Each year the AMT exemption amount automatically adjusts with inflation. The AMT exemption is like a standard deduction for calculating the alternative minimum tax. It’s a flat exemption figure and once you exceed it, each dollar becomes taxable.
The current exemption amounts for 2020 are:
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- $71,700 for single taxpayers
- $111,700 for married taxpayers filing jointly
- $55,850 for married taxpayers filing separately
- $71,700 for taxpayers filing as the head of household
How can I plan for the AMT?
The simplest way to plan ahead for the AMT is to look at your last year's Form 6251 and compare the Tentative Minimum Tax to your regular tax to see how close you were to paying the AMT.
Depending on your annual income and deductions, you could be affected by the AMT in one tax year, but not the next. But if you’re close to the AMT threshold, it’s a good idea to do a projection exercise for a few years out to see which tax years might leave you the most exposed and how to mitigate that risk.
For example, could you accelerate or delay certain transactions to minimize the risk of triggering the AMT? Or what's the best tax year to sell an asset with a large gain?
While triggering the AMT is unfavorable, it's not the end of the world. Be prepared and aware if you are vulnerable, but it shouldn't change the trajectory of your financial goals. Additionally, as tax law is constantly changing, it might be best to work with a CPA to plan for managing your taxes.
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