For many people, the Alternative Minimum Tax will not affect how they calculate their income taxes or how much they will owe. However, understanding its purpose and how it works is important to make sure that you are not underpaying your federal income taxes. Having an understanding of the AMT will help you to make sure you avoid any taxes and audits by the IRS as a result of not figuring your AMT.
The alternative minimum tax came into existence from the 1969 Tax Reform Act. It was originally intended to target rich taxpayers who used various tax benefits to legally avoid paying taxes, or at least a significant portion of the taxes they owed. The AMT requires you to calculate your taxes due using a flat rate but eliminates most of the tax deductions and credits you would otherwise be allowed to claim. If this method causes you to owe more in income taxes, you must use it.
If you think you might owe the AMT, you must figure your taxes using IRS form 6251. This form helps you to recalculate your taxable income by adding back all of the disallowed deductions, such as the mortgage interest deduction and the medical and dental expenses deduction and then taking the AMT exemption to find your income subject to the AMT. After calculating the AMT tax, you have to compare what you would owe under the AMT tax scheme to what you owe under the regular income tax scheme. If the AMT amount is great, you have to use that as your tax liability.
If you claim large deductions for certain tax write-offs, you are more likely to owe money under the AMT. This is because these deductions are disallowed under the AMT calculation formula. According to Fairmark, you are more likely to have to pay the AMT if you claimed deductions for mortgage interest from second mortgages, state and local taxes, and long-term capital gains. In addition, you must also include your incentive stock options and certain bond interest that would not be taxed if you are not subject to the AMT. Smart Money recommends figuring your AMT if you have over $75,000 of income and you claim large write-offs for these deductions or if you have over $100,000 in income total.
Change Over Time
When the AMT was first instituted, it was not indexed for inflation. This means that the income amounts do not change as the cost of living increases. As a result, more and more people have found themselves subject to the AMT. According to Smart Money, only 19,000 people were subject to the AMT when it was first enacted, but millions of people are subject to it in 2010.