Individual taxpayers who have come close to triggering the alternative minimum tax (AMT) in the past should start planning to minimize 2016 taxes as early as possible. This article will define AMT, how it is calculated, and ways to minimize your AMT liability.
What Is It?
The AMT – a separate tax system that doesn’t allow certain deductions and income exclusions – initially was put in place to prevent wealthy Americans from taking so many tax breaks that they eliminated their tax liability. But even taxpayers who don’t normally consider themselves “upper income” can trigger the AMT. For example, you could be vulnerable if you exercised incentive stock options this year.
AMT calculations can be complicated, but the system basically has two tax rates (26% and 28%) and inflation-adjusted income thresholds for them. An exemption is also available, but it phases out based on income. For 2016, the AMT exemptions are $53,900 for single filers and heads of households and $83,800 for joint filers. The phase-out ranges are $119,700 to $332,100 for single filers and heads of households and $159,700 to $493,300 for joint filers. If AMT income is within the applicable range, a partial exemption is available; if it exceeds the top of the range, no exemption is available.
Which Tax Do You Pay?
To determine whether you owe the AMT, you’ll need to calculate your tax under both the regular and AMT systems. If your AMT liability is greater than your regular income tax liability, you must pay the difference as AMT, in addition to the regular tax. The federal AMT rate is 28%, compared to the top regular income tax rate of 39.6 %.
Under the AMT, you can’t take a personal exemption for yourself and your dependents. And you are not allowed to deduct such items as home equity debt interest not used to improve your home; state and local income and property taxes; and miscellaneous itemized deductions subject to the 2% floor.
Those with high incomes are more susceptible to the AMT than others, but AMT liability may also be triggered by:
- Large families (meaning you take many exemptions)
- Substantial itemized deductions for state and local taxes, home equity loan interest, medical expenses, or similar expenditures
- Exercising and holding incentive stock options
- Adjustments to passive income or losses
- Interest income from private activity bonds
How Do You Reduce Your AMT Liability?
Fortunately, strategies exist for minimizing your AMT. For example, you might want to delay sales of highly appreciated assets until the next year or use an installment sale to spread the gains over multiple years. You can also try to time the payment of state and local taxes and other miscellaneous itemized deductions for years that you do not expect the AMT to apply. Or you might want to recognize additional income this year to take advantage of the AMT’s lower maximum rate (28% vs. 39.6%).
There is also an AMT credit. If you pay the AMT in one year on deferral items (those that affect more than one tax year, such as depreciation) you might be entitled to a credit for a subsequent year. The credit, however, might provide only partial relief or take years before you can fully use it. Nonetheless, the AMT credit’s refundable feature can reduce the time it takes to recoup AMT payments.
Most taxpayers do not even realize that the AMT is looming until it’s too late to do anything to manage it. Failing to pay the AMT can lead to penalties and interest, so it’s best to determine ahead of time whether it will apply. Talk to your tax advisor now while you still have time to strategize for 2016.