The government uses the Alternative Minimum Tax to make sure wealthy taxpayers don’t pay too little in taxes. It is essentially a floor on how low your taxes can go. The AMT is a separate calculation of your taxes so that even if you take legitimate deductions that lower your taxes owed, if the AMT is higher, that is the amount you will have to pay. Many of the deductions that are allowed on your Form 1040 are not allowed under the AMT, including some mortgage interest.
What It Does
The AMT is a separate calculation of your taxes that has different rules for income and deductions. If you potentially owe the AMT, you must recalculate your taxable income using the AMT guidelines and compare your AMT liability with your regular tax liability and pay the higher. The AMT keeps high-income earners from paying no income taxes, but it is considered complicated and inefficient. It raises taxes (marginal rates) without Congress having to do anything. It also penalizes couples and large families. Couples are 20 times as likely as singles to face the AMT in 2010. Because the AMT doesn’t allow deductions for dependents, 85 percent of married couples with two or more children will face the AMT, 97 percent among such couples with income between $75,000 and $100,000. About 6 million taxpayers will face the AMT in 2010 simply because they have children, according to the IRS.
Under the existing AMT rules in 2009, you will have to pay the AMT if your taxable income, combined with some AMT adjustments, is more than: $69,950 for married filing joint returns; $46,200 for single or head of household returns; and $34,975 for married filing separate returns.
The AMT does allow for mortgage interest to be deducted from your income if the mortgage is an eligible one. To be eligible, the mortgage must have been used to buy, build or improve a main home or second home “not used on a transient basis.” The IRS has stated that interest paid on a refinanced loan can remain eligible to the extent that the amount of the loan is not increased. The IRS worksheet begins with the Schedule A mortgage deduction and then has you subtract out the eligible portions of the mortgage interest from the ineligible portions.
Properties that you own for rental or timeshare properties would not be eligible for a AMT mortgage deduction, though you would be able to deduct the interest from your Form 1040. Also, if a mortgage was refinanced to take cash out, it would not be eligible. This is one of the ways that the AMT makes your income higher in order to insure taxpayers pay more in taxes.
Only 19,000 people paid the AMT in 1970. By 2008, millions of taxpayers are paying it, according to SmartMoney.com. According to the IRS's National Taxpayer Advocate, the AMT was the most serious problem faced by taxpayers. The reason for the expanded reach is that the AMT tax bracket is not adjusted for inflation. However, inflation generally adds a few percentage points to income each year. So now a tax meant for the rich can affect people with incomes as low as $75,000. And if you have large, totally legal deductions—several children, second mortgage interest, capital gains—you became especially vulnerable to the AMT, according to SmartMoney.com.