Picture this: You’ve just completed your tax return for the year. You’re stoked because you qualified for a ton of deductions this year, so you’re getting a huge refund. You are about to send of your tax return and sit back and wait for a hefty check in the mail, when someone utters three terrifying words to you: Alternative Minimum Tax (AMT).
If you claim a great deal of tax deductions, beware of this silent killer. The alternative minimum tax can come out of nowhere and require you to pay more tax than you ever thought possible.
Here are some facts on the alternative minimum tax so you know what to look out for if your deductions start stacking up this year:
What Is The Alternative Minimum Tax?
The AMT was designed to prevent wealthy taxpayers from using tax deductions as loopholes to get out of paying income taxes. The AMT is a system that is set up very similarly to our regular tax system, except many deductions that you can normally under the regular system take aren’t allowed for the AMT.
The AMT follows a complex formula of adding and subtracting certain adjustments and income items back to your gross income. A tax is finally assessed on the “Alternative Minimum Taxable Income”. If this tax is greater than your tax liability under the regular tax system, then you’ll have to pay the difference.
When the AMT was first put into law, it only affected a small number of people. Now, millions of taxpayers must pay the AMT. The reason? The AMT is not yet indexed for inflation. So while the AMT only taxed the very highest incomes in 1970 ($100,000 and up), it is now taxing the middle-class because our median income has risen over the years.
Will The AMT Affect You?
The makers of TurboTax estimate that over 29 percent of taxpayers earning between $75,000 and $100,000 paid the AMT in 2010. Don’t worry, though, you’ll only be eligible for the tax if you take a very large number of tax deductions. If you only took a handful of tax deductions, you’ve got nothing to worry about. If, however, you’re taking almost all of the available itemized deductions and some other deductions, then you might get hit with the AMT.
To find out if you might have to pay the AMT, ask yourself if you will take or did take a high number of deductions this year that included:
- State, local, and foreign income tax deductions
- Miscellaneous itemized deductions
- Home equity loan interest deductions
- Medical deductions
- Net operating loss deduction
- Passive activity loss deduction
- Property tax deduction
Unfortunately, all of the deductions listed above are not allowed under the AMT tax system. There are a couple other situations that could make you eligible for the AMT. A couple popular ones are if you had a high amount of Private Activity Bond Interest Income (which usually isn’t taxed under the normal system) or if you exercised Incentive Stock Options through your employer.
Another tax perk that isn’t allowed under the AMT system? The standard deduction and personal exemptions are not allowed. The AMT does, however, have its own fairly high set of exemptions. For example, the 2014 AMT exemption for single taxpayers is $52,800.
Tax prep software like TurboTax is great for simple returns and will even alert you if you may have to pay the AMT. If so, you’ll find that the AMT system is very confusing and you might need some professional help if you need to pay it. If you think you may have to pay the AMT, check out IRS Form 6251. It will show just you just which deductions aren’t allowed in more detail than I can list here.
The AMT is one example of where the tax law needs to be updated and improved. What once started as a tax law with good intentions to make all taxpayers pay at least some tax is now hurting more and more middle class taxpayers. Talk with your financial advisor or professional tax preparer if you have more questions about the AMT. The AMT is becoming more and more prevalent, so it’s definitely not something we can just ignore anymore.
As always, good luck with your tax journey this tax season!