Nowadays there are so many different types of taxes out there: AMT tax, FICA taxes, federal income taxes, annual taxes, quarterly taxes… sometimes it can be difficult to differentiate each one and knowing which ones you need to pay.
Let’s dig a little deeper to find out what is AMT tax, who needs to pay it and if it could affect you.
What is AMT tax?
Alternative Minimum Tax (AMT) is a tax targeted at wealthy Americans. AMT tax intends to ensure that rich people pay their taxes instead of using the deductions that are available to them.
The AMT tax has a long history. In the year 1966, the Internal Revenue Service (IRS) discovered that 155 individuals with incomes exceeding $200,000 each hadn’t paid any income tax at all. Consequently, Congress introduced an “add-on” minimum tax to get wealthy people to pay at least a minimum amount of tax.
The modern version of the AMT tax came into being about a decade later in 1979.
How does AMT tax work?
Your understanding of what is AMT tax would be incomplete unless you address this question.
The tax law in the country allows taxpayers to significantly reduce the amount that they are required to pay in taxes. They can do this by taking advantage of the benefits that are available in the form of exemptions and deductions. The AMT tax seeks to limit these benefits.
How will you know whether you are required to pay AMT tax? We’ll tackle this question in the next section.
Who pays AMT tax?
You can find out if you have to pay Alternative Minimum Tax by completing IRS Form 6251.
Remember that two types of taxes operate concurrently. So, that means individuals who may need to pay AMT tax would be required to calculate their tax liability twice. The first calculation would be according to the regular income tax rules, and the second would involve using the AMT regulations.
Which calculation will your tax payment be based on? The IRS stipulates that you pay the higher of the two figures.
When you are trying to make sense of what is AMT tax, you should remember that the calculation involves losing certain deductions that are available under the regular tax rules. Here are some of the amounts that would increase your income to calculate AMT tax:
- Real estate and personal property taxes are not allowed as deductions to arrive at your alternative minimum tax income (AMTI).
- Medical expenses are allowed only under specific circumstances.
- The tax-exempt income that you earn on private activity bonds will be included in your AMTI.
How many people does AMT tax affect?
In 2017, five million American taxpayers paid Alternative Minimum Tax. However, there’s good news on this front.
The Trump administration’s Tax Cuts and Jobs Act has diluted the effect of AMT tax significantly. The Tax Policy Center (TPC), a think tank based in Washington D.C., has estimated that the number of Americans who paid AMT in 2018 was 200,000. This number is expected to remain constant through 2025. In that year, the income tax measures in the Tax Cuts and Jobs Act are likely to expire.
Source: Tax Policy Center
How is AMT tax calculated?
Alternative Minimum Tax can be calculated by using IRS Form 6251.
It’s a complicated calculation, and unless you are good with numbers and familiar with how the tax laws work, you should use professional help.
Read our post Where To File Taxes For Your Small Business for tips on filing taxes.
Here are the steps involved in the AMT tax calculation:
- Calculate your Alternative Minimum Tax income by adding or eliminating the relevant exclusions and deductions. You can find the list of the items you need to consider on page 98 of the IRS instructions for filing Form 1040.
- Reduce the alternative minimum tax income by the AMT exemption amount.
- Apply the relevant AMT tax rate.
- Subtract AMT foreign tax credit, if applicable.
When learning what is AMT tax, and its implication in dollar terms, you must know the tax rates as well as the exemption limits.
The AMT tax exemption limit for the years 2018 – 25 is $70,300. If the taxpayer is married and filing jointly, this goes up to $109,400. For married individuals filing separately, the exemption limit is $54,700.
There’s another crucial piece of information that you should be aware of. The AMT exemption begins to phase out after a specific income. This has been set at $500,000 for each individual. The phase-out starts at $1,000,000 if the taxpayer is married and is filing jointly.
Here’s the information in a tabular form:
Source: Tax Policy Center
There are two AMT tax rates. Income up to $191,000 is taxed at 26%. Any amount above this threshold attracts an AMT tax rate of 28%.
What if you don’t have the funds to pay your AMT tax?
You can consider taking a tax loan to raise the money. Although this would involve paying interest to the lender, it is better than defaulting on the tax payable.
If you don’t pay your taxes, the IRS can make a claim against your property. Consequently, a lien could be created on your assets. Although there are ways to remove a tax lien, the process could be both lengthy and cumbersome.
AMT tax breaks
When you file your taxes, there are many tax deductions for business owners that you can take advantage of. Similarly, there are ways to reduce your AMT tax.
At this stage, let’s go back to the question of what is AMT tax.
It’s essentially a tax to ensure that individuals who benefit from the exemptions and deductions available under the regular tax law pay at least a certain minimum tax.
AMT tax is calculated by first computing your regular tax. You are then required to add back certain items. This will increase your income and help you to arrive at your alternative minimum taxable income. So, if you can identify the deductions that reduce your regular tax, you will be able to anticipate how your income for AMT tax will be calculated.
Some of these deductions are:
- Accelerated depreciation.
- Qualified electric vehicle credit.
- The expense incurred for investments.
- The exclusion that you have claimed for gain in certain small business stock sales (Section 1202)
However, you should remember that if you do take advantage of these deductions for computing your regular taxes, you have no option but to add them back for computing your AMT income.
You can see a complete list of the relevant deductions here.
How to avoid the AMT tax?
Avoiding AMT tax refers to the legal methods by which you can lower or eliminate the taxes you owe the IRS. When you are considering the question of “what is AMT tax?” you must remember that if your regular tax bracket is higher than 28%, then you will not have any AMT tax liability. That’s because you are already paying a higher amount in regular taxes.
However, if your regular tax bracket is lower than 26% or 28%, you may be liable to pay AMT tax. Here are some ways in which you can reduce it:
- The interest you pay on a home equity loan is deductible when you calculate your regular taxes even if you use the funds for personal purposes. However, for the AMT tax calculation, the home equity loan interest is deductible only if you use the money for buying your home or building or improving it. Keep this in mind if you think that you may need to pay AMT tax.
- Employees may consider signing up for a pre-tax medical deduction plan if their employers offer one. This can help to reduce your AMT tax as well as your regular tax.
Remember that real estate and property taxes aren’t deductible for calculating AMT tax. So, don’t prepay these taxes as the payment will not help to reduce your AMT tax.
You’ll see that it isn’t much you can do to lower your AMT tax. The IRS has designed the tax in a way that ensures that high-income individuals can’t avoid it.
AMT tax, like all other taxes, are important
With the recent change in laws, far fewer people need to know what is AMT tax. Now, instead of millions of individuals being affected, only about 200,000 people need to pay this tax.
That’s a big relief for most American taxpayers.
Tax payments aren’t the only issue that small business owners contend with. Funds could be required for several purposes – you may need cash for meeting your wage bill, paying for new machinery, or a new marketing campaign. If you find yourself short of money, we, at Camino Financial, can help. Our motto is “No business left behind.” So, you can be sure that we will do our best to provide you with the funds you need.