Alternative Minimum Tax Basics

There was a time when the "rich" avoided paying most, if not all, income taxes by taking advantage of loopholes in the tax code. To end this, the government came up with the alternative minimum tax (AMT) in 1969. It's a different way to calculate a tax bill. The idea was to make sure that all taxpayers paid at least their fair share of income taxes.

Today, however, it's not just the rich who have to pay the AMT. Many middle class taxpayers find themselves having to pay it, mainly because of inflation and increased incomes. So, practically everyone needs to know some things about what the AMT is and how it works.

What's the AMT, Anyway?

The AMT is a second tax scheme that's completely different from the one we're all familiar with. The AMT has its own set of deductions, rules and tax brackets. Generally, under the AMT you lose almost all the deductions and exemptions you normally get under the regular scheme and you take a special AMT exemption.

What You Can't Claim or Deduct

Unlike in the regular tax scheme, for the AMT you can't:

• Claim exemptions for yourself or your dependents
• Take the standard deduction
• Take itemized deductions for state and local income taxes and real estate taxes
• Take itemized deductions for home equity loan interest, unless the loan was for buying, building or improving your home
• Take itemized deductions for miscellaneous deductions, like business expenses and some medical expenses
• Exclude any gain you have during the year under your employer's incentive stock option (ISO) plan

In the AMT scheme, these are called adjustments or preferences, and there are many of them. The idea is to close all of the loopholes that wealthy taxpayers can use to reduce their taxes, and then tax their income at lower rates.

Figuring the AMT

In simplified form, you calculate the AMT by:

• Calculating your alternative minimum taxable income (AMTI). You do that first by figuring out your regular taxable income - using the regular tax scheme and Form 1040. Then, you add back into your taxable income the adjustments and preferences listed above
• Deducting your AMT exemption. The AMT exemption for 2010 is $72,450 for a married couple filing a joint return and qualifying widows and widowers; $47,450 for singles and heads of household; and $36,225 if you're married filing separately
• Applying the special AMT tax rates or tables. The special AMT Tax rate is 26 percent on the first $175,000 (or $87,500 if you're married and filing separately), and then 28 percent on any amount over $175,000. This is called your tentative minimum tax
• Comparing the amount of taxes you owe under the regular tax system and your tentative minimum tax. If your regular taxes are more, you pay the regular taxes. If the tentative minimum tax is more than your regular taxes, your AMT is the difference between the two amounts

As you can see, calculating your AMT is a complicated, multi-step process. The IRS has a tool to help you figure out if and how much AMT you owe. Also, the instructions for the special AMT form has a worksheet that walks you through the calculation.

Not Just for the "Rich" Anymore

Each year, more and more taxpayers have to pay the AMT, especially middle class taxpayers. For the most part, that's because none of the AMT exemptions or tax rates are adjusted for inflation. In other words, the AMT scheme assumes that you can live on the same amount income today that you lived on several years ago. So, as your income goes up, you get closer to the AMT limits.

Do you have to worry about calculating the AMT? There are several things that could trigger the AMT, and you probably should calculate the AMT if you:

• Have several children or dependents and you normally claim exemptions for them
• Normally take itemized deductions for interest on a home equity loan
• Have income from rental property
• Live in a state with high income taxes and normally take a deduction for those taxes
• Have interest income from private-activity bonds - tax-exempt bonds issued by a state or local government to pay for special projects that benefit the public, such as building a museum

So don't skip the line on your tax form for the AMT. Make sure you're not part of the middle class having to pay this tax and know your numbers are right when you send off your tax return.

Questions for Your Attorney

• Is there any way to avoid the alternative minimum tax?
• If I paid the AMT in 2009 will I have to pay it 2010?
• I had to pay the AMT in 2010, and now I'm thinking of taking out a home equity loan to pay for my child's college tuition. Is that a good idea?