The Alternative Minimum Tax (AMT) was originally targeted at wealthy people with creative tax advisors or large amounts of certain kinds of deductions and exemptions. Next year it just might apply to you.

Unlike most tax laws, the AMT is not adjusted for inflation and has gone largely unchanged for 30 years. Consequently, it applied to more and more people each year. 19,000 households paid the AMT in 1970. 2.4 million did in 2003.*

Who Will Pay the AMT in 2005?**

17% of taxpayers earning between $75,000 and $100,000
39% of those earning between $100,000 and $200,000
78% of those earning between $200,000 and $500,000

Will You Have to Pay the AMT?

*Source: Urban-Brookings Tax Policy Center, The AMT: Projections and Problems, July 7, 2003, Table 2: AMT Participation Rate, Microsimulation Model (version 0503-1)

**Source: Urban-Brookings Tax Policy Center, The Individual Alternative Minimum Tax: A Data Update, August 30, 2004, Table 2: AMT Participation Rate, Microsimulation Model (version 0304-3).

Before using the Fidelity Tax Center, review important legal information and terms of use applicable to products, services, and/or information provided by, or accessed through, the Tax Center by the following companies:

Fidelity Investments H&R Block Intuit CCH

Alternative Minimum Tax 101

A brief overview of the alternative minimum tax (AMT).

The alternative minimum tax (or AMT) is an extra tax some people have to pay on top of the regular income tax. The original idea behind this tax was to prevent people with very high incomes from using special tax benefits to pay little or no tax. But for various reasons the AMT reaches more people each year, including some people who don't have very high income and some people who don't have lots of special tax benefits. Congress is studying ways to correct this problem, but until it does, almost anyone is a potential target for this tax.
The name comes from the way the tax works. The AMT provides an alternative set of rules for calculating your income tax. In theory these rules determine minimum amount of tax that someone with your income should be required to pay. If you're already paying at least that much because of the "regular" income tax, you don't have to pay AMT. But if your regular tax falls below this minimum, you have to make up the difference by paying alternative minimum tax.

How do I know if I have to worry about the AMT?

Unfortunately, there's no good answer to this common question — which is one of the big problems with the AMT. You can have AMT liability because of one big item on your tax return, or because of a combination of many small items. Some things that can contribute to AMT liability are mundane items that appear on many tax returns, such as a deduction for state income tax or interest on a second mortgage, or even your personal and dependency exemptions. See Top 10 Things that Cause AMT Liability.
If you use computer software to prepare your tax return, the program may be able to do the AMT calculation. If you're preparing a return by hand, the only way to know for sure is to fill out Form 6251 — a laborious process.

There are two essential pieces to the AMT. First, you need to understand how your AMT liability is calculated for a year when you pay AMT. And second, you need to know how the AMT credit can reduce your taxes in years after the year you paid alternative minimum tax.

AMT Liability

The best way to understand alternative minimum tax liability is to see how it's calculated. Here's the big picture.

Compute an Alternate Tax

First, you figure the amount of tax you would owe under a different set of rules. What's different about these rules? Broadly speaking, three things:

Various tax benefits that are available under the regular tax are reduced or eliminated.
You get a special deduction called the AMT exemption, which is designed to prevent the AMT from applying to taxpayers with modest income. This deduction phases out when your income reaches higher levels, a fact that causes significant problems under the alternative minimum tax.
You calculate the tax using AMT rates, which start at 26% and move to 28% at higher income levels. By comparison, the regular tax rates start at 10% and then move through a series of steps to a high of 35%.

The result of this calculation is the amount of income tax you would owe under this "alternative" system of tax.

Compare with the Regular Tax

Then you compare this tax with your regular tax. If the regular tax is higher, you don't owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT you have to pay.

Example 1: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $39,000. That's lower than the regular tax, so you don't pay any AMT.

Example 2: Your regular income tax is $47,000. When you calculate your tax using the AMT rules, you come up with $58,000. You have to pay $11,000 of AMT on top of the $47,000 of regular income tax.

If you're paying attention, you've probably noticed that the total amount of tax you pay in Example 2 is equal to the tax calculated under the AMT: $58,000. But it's important to note that you actually pay $47,000 of regular tax plus $11,000 of AMT, as we'll see below.

Reporting: To calculate and report your AMT liability you need to fill out Form 6251, Alternative Minimum Tax — Individuals.

Estimated tax: You're required to take your AMT liability into account in determining how much estimated tax you pay. For information about estimated tax payments, see Guide to Estimated Tax.

AMT Credit

Here's good news: a portion of your AMT liability — perhaps all — may reduce the tax you pay on future tax returns. Working with this AMT credit is a two-step process. First you find out how much credit is available, then you find out how much of the credit you can use.

Find the Available Credit

The first part of your task is to find out how much of the AMT liability from a prior year is eligible for the credit. This involves calculating the alternative minimum tax under a different set of rules — sort of an alternative AMT. What you're doing here is finding out how much of your alternative minimum tax liability came from timing items: items that allow you to delay reporting income, as opposed to items that actually reduce the amount of income or tax you report. If you're lucky, your entire AMT will be available as a credit in future years. But some people find that only a small portion, or none at all, is available for use as a credit.

Determine How Much AMT Credit You Can Use

If you have some AMT credit available from a prior year, you have to determine how much of the credit you can use in the current year. You can only use the AMT credit in a year when you're not paying alternative minimum tax.
The amount of credit you can use is based on the difference between your regular tax and the tax calculated under the AMT rules.

Example: Suppose you have $8,000 of AMT credit available from 2003. In 2004 your regular tax is $37,000. Your tax calculated under the AMT rules is $32,000. You don't have to pay AMT because your regular tax is higher than the tax calculated under the AMT rules. Better still, you're allowed to claim $5,000 of AMT credit, reducing your regular tax to $32,000.

In this example, you would still have $3,000 of AMT credit you haven't used. That amount will be available in 2005. In tax lingo, it's carried forward.
Of course, you can't claim more than the amount of the available credit. In the example, if the AMT credit available from 2003 was $2,700, then you would use the full amount of the credit in 2004. You would reduce your regular tax to $34,300 — not all the way to $32,000.
Reporting: To calculate and report your AMT credit you need to fill out Form 8801, Credit for Prior Year Minimum Tax — Individuals, Estates, and Trusts.

Top Ten Things that Cause
AMT Liability

An overview of some of the things that may cause you to pay alternative minimum tax (AMT).

This page provides a list of items that can cause (or contribute to) liability under the alternative minimum tax. The list isn't complete — there are other items that can contribute to AMT liability. Based on our experience, the items described below are likely to affect more people than other items. For a complete list, see Form 6251, Alternative Minimum Tax — Individuals and the instructions for that form. By the way, if you count more than 10 items below, just consider it a bonus.

Exemptions

Believe it or not, exemptions contribute to AMT liability. The exemptions you claim for yourself, your spouse and your dependents are not allowed when calculating alternative minimum tax. It's pretty rare (though not impossible) to see a tax return where someone had to pay AMT solely because of their exemptions, but the more exemptions you claim, the more likely it is that you'll have AMT liability when all is said and done.

Standard Deduction

Some 70% of American taxpayers claim the standard deduction (rather than itemizing). The standard deduction isn't allowed under the AMT. Usually this isn't a problem because the AMT generally hits people with higher incomes, and these people are more likely to claim itemized deductions. Yet it's worth noting that a deduction that's so widely used can contribute to AMT liability.

State and Local Taxes

If you itemize, there's a good chance you claim a deduction for state and local tax, including property tax and state income tax. For 2004 and 2005, you can claim a deduction for sales tax if you don't claim a deduction for state or local income tax. These deductions are not allowed under the AMT. If you live in a place where state and local taxes are high, you're more likely to be subject to the alternative minimum tax.

Interest on Second Mortgages

The AMT allows a deduction for interest on mortgage borrowings used to buy, build or improve your home. If you borrowed against your home for some other purpose, the interest deduction isn't allowed under the alternative minimum tax.

Medical Expenses

The AMT allows a medical expense deduction, but it's more limited than the deduction under the regular income tax. If you claim an itemized deduction for medical expenses, part or all of it will be disallowed when you calculate your alternative minimum tax.

Miscellaneous Itemized Deductions

Certain itemized deductions are available if your total in this general category is more than 2% of your adjusted gross income. Among the items here are unreimbursed employee expenses, tax preparation fees, and many investment expenses. You can't deduct these items under the AMT, though. If you claim a large number in this area, you could end up paying alternative minimum tax.

Various Credits

Many of the credits that are allowed when you calculate your regular income tax aren't allowed when you calculate your AMT. The more credits you claim, the more likely it is that you'll end up paying alternative minimum tax. Fortunately, Congress has extended relief for the "personal credits" in recent years.

Incentive Stock Options

Generally you don't report anything on your regular income tax at the time you exercise an incentive stock option. But you have to report income for purposes of the AMT. Exercising a large incentive stock option is almost certain to cause you to pay alternative minimum tax.

For more about the AMT consequences of incentive stock options see our online Guide to Compensation in Stock and Options — or our book, Consider Your Options.

Long-Term Capital Gains

Long-term capital gains receive the same preferential rate under the AMT as they do under the regular income tax. In theory, they shouldn't cause you to pay alternative minimum tax. In practice, it's possible to be stuck with AMT liability because of a large capital gain. The reasons are a little complicated, but mainly have to do with the fact that a large capital gain reduces or eliminates the AMT exemption amount, which is designed to protect low-income taxpayers from having to pay alternative minimum tax.

Tax-Exempt Interest

Interest that's exempt from the regular income tax may or may not be exempt from the AMT. It depends on complicated rules that are fully understood only by bond lawyers. Bonds that aren't exempt from AMT pay a slightly higher rate of interest to compensate for the fact that they aren't fully tax-exempt. If you invest in bonds that aren't exempt under the alternative minimum tax, you're a candidate for AMT liability.
Many mutual funds that provide exempt interest invest at least some of their money in bonds that aren't exempt under the AMT, to get a higher rate of interest. Their annual statement tells you how much of the exempt interest dividend you received during the year is taxable under the alternative minimum tax.

Tax Shelters

The Tax Reform Act of 1986 severely curtailed the ability to reduce income tax through tax shelters. Yet there are still some legitimate ways of reducing tax liability through investments in certain types of partnership or limited liability company arrangements involving such activities as oil and gas drilling. The AMT provides reduced tax benefits for these activities. You should always explore the alternative minimum tax consequences (among other things) before investing in a tax shelter.

AMT and Long-Term Capital Gain

Here's how you can encounter the alternative minimum tax (AMT) because of a long-term capital gain.

Congress didn't intend for the alternative minimum tax to apply merely because you have a long-term capital gain. When Congress reduced the capital gain rates in 1997 and again in 2003, it provided that the lower rates would apply under the AMT, too. But the way it works out, you may still pay AMT because of a large long-term capital gain.

The AMT Exemption

A major reason for paying AMT in the year of a large capital gain is the AMT exemption. This is a special deduction that's designed to prevent the alternative minimum tax from applying at lower income levels. The problem is that the AMT exemption is phased out when your income goes above a certain level. Capital gain is income, so it can reduce or eliminate your AMT exemption.
For example, if you're single and your income under the AMT rules is $112,500 or less, you're allowed an AMT exemption of $40,250. (This is the amount for 2003 and 2004; after that Congress will have to take action to prevent the exemption amount from falling back to a lower level.) Normally that's enough to prevent you from paying AMT unless you're able to claim special tax benefits that reduce your regular tax. But suppose your income is around that level before you add a $200,000 capital gain (sale of a real estate investment, or stock, or perhaps sale of a business you built up). Your tax on the capital gain is 15% under both the regular tax and the AMT: $30,000. But under the AMT, the added income wiped out your AMT exemption.
How big is the effect? The answer depends on how close you are to paying AMT before this happens. Overall, though, a large capital gain can cause you to incur $10,000 or more of AMT.

Do the Math

Here's how it works. For every $1,000 of added long-term capital gain, your regular income tax goes up by $150 (15%). When we move over to the AMT, the same $1,000 is taxed at 15%, but in addition eliminates $250 of your exemption amount, because the exemption is phased out at a rate of 25%. The exemption amount is used to reduce the amount of tax you pay on your ordinary income (the income that is taxed at either 26% or 28% under the AMT). So your tax under the AMT rules goes up by about $70, which is 28% of this added $250. You didn't really add another $250 of income, but your exemption amount went down by $250, and that exposed another $250 of your existing income to tax under the AMT.
Result? Under the AMT, adding $1,000 of long-term capital gain can increase your tax by as much as $220, consisting of the $150 tax on the gain itself and the $70 that hits you because the exemption amount is reduced. In effect, you're paying 22% on the gain under the AMT and 15% on the gain under the regular income tax, so a big capital gain can lead to a big AMT bill.
That doesn't necessarily mean you pay AMT every time you have a long-term capital gain. Most people have at least a little bit of a cushion between the amount of regular tax they pay and the level where they would have to start paying alternative minimum tax. (The size of your cushion depends on various items. See Top 10 Things that Cause AMT Liability.) Besides, the capital gain can cause some tax benefits to phase out under the regular tax, too. But there's a good chance you'll pay AMT if your income is in the range where the exemption amount is phased out and you have a large long-term capital gain.

More Bad News

There's more bad news. People who get caught by the AMT because of a large long-term capital gain usually don't qualify for the AMT credit in later years. The AMT is being caused by items that aren't considered timing items. Possibly you have some timing items in addition to the large capital gain, and in that case at least part of your AMT would be available as a credit in later years. Typically this added tax is just a dead loss.

What to Do

In many cases there isn't a heck of a lot you can do about this added tax. But if you're aware of the issue, you may be able to take measures to reduce the impact.

Timing your capital gains. In some situations you can control the year in which you report capital gains. You may be able to delay a sale until after the end of the year, or spread the gain over a number of years by using an installment sale. There's no simple answer to whether these measures help or hurt, so someone has to sharpen a pencil and grind out some numbers.
For example, your gain may be at a level where spreading it over a number of years will keep you out of the AMT — or at least reduce the impact. In this case an installment sale might be an attractive alternative. But suppose your gain is so large that it will phase out your AMT exemption amount many times over. In this situation, you may get a better result by reporting all the gain in one year, so you're only affecting one year's exemption amount.

Timing other items. Another way to plan for the AMT is to see if you can change the timing of other items that are affected by the tax. For example, if you make estimated payments of state income tax, you may try to schedule your payments so they don't fall in the same year as your large capital gain. Of course you have to take any potential penalties into account with the tax savings if you take this approach.

Dual Basis Assets

Some assets have a different basis under the alternative minimum tax (AMT) than under the regular tax.

Your basis in an asset, such as stock or real property, is used to determine how much gain or loss you report when you sell that asset. (Basis may be used for other purposes as well.) In some situations an asset may have one basis for regular income tax purposes and a different basis (usually higher) for alternative minimum tax purposes. When that happens, the AMT gain or loss on a sale of that asset won't be the same as the regular tax gain or loss. If you're not alert to this situation you may end up paying more tax than necessary.

What Causes Dual Basis

Ordinarily, your basis for an asset is simply the amount you paid for it plus any costs of acquisition (such as brokerage fees). But various events can cause an adjustment in the basis of an asset. For example, if you claim a deduction for depreciation of an asset, you reduce your basis in that asset by the amount of the deduction.
Some of the things that cause an adjustment in basis under the regular tax have a different treatment under the alternative minimum tax. For example, you may have to use a less favorable depreciation schedule for AMT purposes than you use for the regular tax. That means you've claimed smaller depreciation deductions for that asset under the AMT, and as a consequence will have a higher basis in the asset.

Example: Over the years you've used a piece of equipment that cost $20,000, you've claimed depreciation deductions of $12,000, leaving you with an adjusted basis of $8,000. During those same years, your AMT depreciation deductions for the same piece of equipment were $9,000. That means your AMT basis is $11,000.

Incentive Stock Options

One very important circumstance where you can have dual basis in an asset is when you exercise an incentive stock option. You have to report an adjustment for AMT purposes when you exercise an incentive stock option. As a result you may end up paying alternative minimum tax. But another result is that your AMT basis in the stock is increased by the amount of the adjustment.

Example: At a time when your company's stock was trading at $80 per share, you exercised an incentive stock option to purchase 500 shares at $24 per share. For AMT purposes you report an adjustment of $28,000 ($56 per share). The result is that you hold stock with a basis of $24 per share for regular tax purposes and $80 per share for AMT purposes.

Sale of a Dual Basis Asset

When you sell a dual basis asset, you report the difference between the regular tax gain or loss and the AMT gain or loss as an adjustment. If your AMT basis is higher (as is usually the case), you report this item as a negative adjustment. The result may be to reduce the amount of AMT you pay or increase the amount of AMT credit you can use.

Example: In the preceding example, you held stock with a basis of $24 per share for regular tax purposes and $80 per share for AMT purposes. If you sell the stock for $100 per share and have no other capital gains or losses, you should report a negative adjustment of $56 per share on your AMT calculation. If you have to pay AMT in the year of the sale, this adjustment will reduce your alternative minimum tax liability. If you don't have to pay alternative minimum tax in the year of the sale, the adjustment may make it possible to claim a larger portion of your AMT credit in that year.

The difference between the regular tax gain or loss and the AMT gain or loss isn't necessarily the same as the adjustment you reported when you exercised the option.
Example: You exercised an ISO with a spread of $50,000. During the period you held the stock its value declined, and you sold it for a profit of $12,000. Under the AMT you had a loss of $38,000, but because of the capital loss limitation only $3,000 of this loss is allowed in the current year (unless you have other capital gains to absorb the loss). The difference between your regular tax gain or loss (a gain of $12,000) and your AMT gain or loss (a loss of $3,000) is $15,000, and that's the amount of the adjustment you report when you sell the stock. You also have an AMT capital loss carryforward you can use in future years to recover more of your AMT credit if you didn't recover the entire amount in the year you made this sale.

Claiming AMT Credit

Are you overlooking an opportunity to claim AMT credit?

Certain items under the alternative minimum tax (AMT) give rise to a credit you can claim in a later year. You don't get to claim AMT credit if you paid AMT because you had a large number of exemptions, or a large itemized deduction for state and local taxes. Yet you may be able to claim AMT credit if you paid AMT because you exercised an incentive stock option. The credit can also apply when AMT arises from certain other "timing items," such as an AMT adjustment relating to accelerated depreciation.

Many people assume that if the AMT credit arises from exercising an incentive stock option, they can't claim the credit until they sell the shares they acquired by exercising the option. That's not the case. Selling ISO shares may help you claim a larger AMT credit, but you can claim the credit without selling shares — if your regular income tax is larger than the tax figured under the AMT rules.

Example: Suppose you exercised an incentive stock option in 1999, planning to sell the shares when they matured in 2000. You paid $10,000 of AMT on your 1999 tax return, but the share value dropped before you had a chance to sell. You decided to hold on and see if the value of the shares would recover. Several years later you still hold the shares, and now you're wondering if you can sell the shares to claim the credit.

Chances are that you could have recovered thousands of dollars in AMT credit already, on your tax returns for years 2000 through 2003. You didn't have to sell the shares to claim the credit. You simply had to file Form 8801 with your tax return. Depending on your situation — income level, filing status, number of personal exemptions and so forth — you may find that you were entitled to hundreds or even thousands of dollars of credit each year without selling the shares.

Here's the rule: If you pay AMT because of exercising an incentive stock option, you need to file Form 6251 for the year of exercise. Then every year after that you need to file both Form 6251 and Form 8801 until you've claimed the entire credit.

You Didn't File?

If you didn't file Form 8801 with your prior year returns, you need to amend those returns, for two reasons. One is that you could have a nice refund check coming. And the other is that there's no way to claim the credit in a later year without filling out this form for the years intervening between the year you paid AMT and the year you claimed the credit.

That's because the amount of credit available for you to claim depends on what happened in each year. You don't know the amount of your credit carryover to 2004 without filling out this form for 2003. But to fill it out for 2003, you need the numbers from Form 8801 for 2002 — and so on, back to the year you paid AMT.

Time is Running Out

As a general rule you're allowed to go back and amend tax returns for three years. If you failed to claim AMT credit that was available for your year 2001 tax return, you need to file the amended return by April 15, 2005 (or three years after the actual filing date if you applied for an extension and filed within the extension period).

Why not just forget about those prior years and claim the credit beginning in 2004? The answer is that it just doesn't work that way. The amount of credit that carries over from one year to the next depends on the specifics of your tax return for each intervening year, not that amount of credit you actually claim. In other words, use it or lose it!

Tax Rate Tables: Alternative Minimum Tax

The alternative minimum tax applies if it exceeds the regular tax (that is, the tax from the tax tables, rate schedules, etc.). You may have to pay the alternative minimum tax if you:

Claim a large number of exemptions.
Itemize deductions and claim large deductions for taxes and/or miscellaneous deductions subject to the 2% of AGI limit.
Take out a home mortgage or equity line of credit and use the proceeds for a purpose other than to buy, build, or substantially improve your home.
Exercise incentive stock options and did not dispose of the stock in the year of the exercise.

Other less common items may apply. See the instructions for Form 6251.

Alternative Minimum Tax
	2005	2006
Tax Rate on Alternative Minimum Taxable Income	26% up to $175,000 ($87,500 MFS), 28% in excess of these amounts	Same
Exemption	$40,250 (SGL,HH) $29,000 (MFS) $58,000 (MFJ,QW)	$42,500 (SGL,HH) $31,275 (MFS) $62,550 (MFJ,QW)
Minimum Exemption for Dependent Children Under Age 14 for 2005 (18 for 2006)	Earned Income + $5,850	Earned Income + $6,050

Last Update: May 18, 2006

Return to Tax Rate Tables

Tax Estimator

Estimate your taxes with Intuit's comprehensive Tax Estimator!

Estimates your 2005 income taxes
Reflects key aspects of the latest tax laws except for the Katrina Emergency Tax Relief Act (KETRA) and the Gulf Opportunity Zone Act of 2005
Estimates your tax bracket and average income tax rate

Right Arrow Estimate your taxes

Back to the Future

Saturday, August 12, 2006

Alternative Minimum Tax (AMT)

Who Will Pay the AMT in 2005?**

Will You Have to Pay the AMT?

Related Links

Alternative Minimum Tax 101

AMT Liability

Compute an Alternate Tax

Compare with the Regular Tax

AMT Credit

Find the Available Credit

Determine How Much AMT Credit You Can Use

Top Ten Things that Cause AMT Liability

Exemptions

Standard Deduction

State and Local Taxes

Interest on Second Mortgages

Medical Expenses

Miscellaneous Itemized Deductions

Various Credits

Incentive Stock Options

Long-Term Capital Gains

Tax-Exempt Interest

Tax Shelters

AMT and Long-Term Capital Gain

The AMT Exemption

Do the Math

More Bad News

What to Do

Dual Basis Assets

What Causes Dual Basis

Incentive Stock Options

Sale of a Dual Basis Asset

Claiming AMT Credit

You Didn't File?

Time is Running Out

Tax Estimator

0 Comments:

About Me

Previous Posts

Top Ten Things that Cause
AMT Liability